cost of living for everyone. the effect of these developments on households and the way they respond will have implications not only for the broader economy, they will also highlight the financial vulnerabilities that have been building in the household sector. my focus here is therefore going to be mainly on indebted homeowners. around one - third of all households have housing debt. this is not to suggest that other households are unaffected by rising interest rates and inflation – clearly there are implications for renters and those who own their homes outright – but indebted households pose more direct potential risks to the financial sector. and as i have discussed previously, they might also react to interest rate rises in ways that exaggerate housing price and consumption cycles. so the impacts on, and reaction of, indebted households to higher interest rates is going to be important in understanding how the economy and the financial sector might be affected. i will first set out some facts on household balance sheets at an aggregate level. then i will talk about the distribution of debt and where some of the vulnerabilities might lie. finally, i will present some simple scenarios on the potential financial impact of increasing interest rates. i will finish with a few concluding remarks. households in aggregate are well positioned … first a bit of scene setting. if you have been reading our financial stability reviews over the past few years you would be familiar with the theme of high household debt. the household credit - to - income ratio is currently around 150 per cent ( graph 1 ). [ 1 ] this is high relative to the early 1990s. most of the run - up was through the 1990s and the first half of the 2000s. this reflected a combination of lower inflation, financial deregulation, a decline in real interest rates and strong income growth – all of which allowed households to service higher levels of debt. [ 2 ] since then it has remained relatively steady at a high level as nominal incomes have largely kept pace with increased debt. graph 1 household credit % household credit - to - income ratio * % % % housing credit growth * * * * * sum of housing credit and personal credit ; housing credit is net of redraw balances. six - month - ended annualised terms. sources : abs ; apra ; rba the high level of debt held by australian households might, on its own, suggest that many households will face difficulties as interest rates rise, with implications for their ability to service that debt, consumption and the economy

principal payments additional mortgage payments * other saving * * - 5 * * * sum of net flows into redraw and offset accounts. net of depreciation. sources : abs ; apra ; rba - 5 graph 4 flows into housing loan and offset accounts * share of disposable income, quarterly % % interest scheduled principal offset and redraw * seasonally adjusted and break - adjusted. sources : abs ; apra ; rba this large stock of mortgage prepayments is relevant to our assessment of household indebtedness and the risks it presents. large buffers allow households to smooth their spending and maintain required debt payments when faced with lower income or cash flows or higher expenses. in fact, if we take these savings into account, the ratio of household credit to income is actually a fair bit lower than the headline figure and is around the same as its 2007 level ( graph 5 ). graph 5 household credit - to - income ratio % % household credit net of offset accounts household credit * * sum of housing credit and personal credit ; housing credit is net of redraw balances. sources : abs ; rba this is all at an aggregate level. but we also see similar trends from disaggregated data on individual mortgages, as revealed in the reserve bank's securitisation dataset and survey data. the ratio of liquid assets to income has increased substantially among indebted households over recent decades, and borrowers with the most debt also tend to have the highest liquidity buffers. [ 3 ] among households with variable - rate owner - occupier mortgage debt, around half have accumulated enough prepayments to service their current loan repayments for almost two years or longer. these payment buffers help to protect against the risk that, as interest rates rise, households will find themselves unable to meet debt repayments. second, the strength of lending standards in recent years gives us reason to be confident in the ability of many households to absorb some increase in interest rates. for many years, banks have been required to stress test new borrowers'ability to meet repayments with interest rates that are significantly higher than the rate on the loan they have applied for. in 2019, apra indicated to banks that, in assessing loan applications, it expected them to apply a ‘ serviceability buffer ’ of at least 2. 5 percentage points. in october 2021, they increased this to a minimum of 3 percentage points. as a result