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The Reserve Bank's October Financial Stability Review pushed unemployment, inflation and interest rates sharply higher at the same time to see how mortgage holders would cope – and found that the share at higher risk of default would rise to around 5 per cent.

Unemployment at 6.3 per cent. Inflation at 7 per cent. A cash rate of 5.6 per cent. None of these is a forecast. Together they form the severe scenario the Reserve Bank of Australia (RBA) used in its October 2026 Financial Stability Review (FSR), released on 1 October, to test how much strain the mortgage market could take.

The RBA's description of the result was specific. In a scenario where the "unemployment rate increases to 6.3 per cent, inflation increases to 7 per cent, and the cash rate rises to 5.6 per cent – the share of mortgagors at a higher risk of defaulting on their loans is estimated to increase to around 5 per cent".

According to the Review, that is only a little higher than the peak in 2023, and about two-thirds of those borrowers would still have buffers to service their debts for at least six months. To understand why the RBA regards that as a sign of resilience, it helps to look at how far each part of the scenario sits from where the economy is today.

Three dials, all turned up at once

Stress tests are designed to combine bad outcomes that would hurt borrowers from several directions simultaneously. This one pulls three levers.

Unemployment. Governor Michele Bullock said on 29 September that the unemployment rate "has risen from 3.5 per cent over the past couple of years to 4.6 per cent". The scenario's 6.3 per cent is 1.7 percentage points higher than that. It is also well above the RBA's own August forecast, which said: "The unemployment rate is forecast to increase to 4.8 per cent by the end of 2028". Job losses matter for mortgage stress because they can cut household income suddenly.

Inflation. The August monthly CPI indicator put headline inflation at 4.0 per cent, while Bullock said underlying inflation has been about 3.5 per cent for the past six months. The RBA's target range is 2–3 per cent. A 7 per cent inflation rate in the scenario would be 3 percentage points above the latest headline figure, squeezing household budgets through the cost of essentials. For historical perspective, Bullock told federal MPs on 18 September that "Inflation fell significantly from its peak of 7.9 per cent at the end of 2022".

The cash rate. The cash rate target has been 4.60 per cent since 30 September, after the Monetary Policy Board's 25 basis point increase on 29 September. The scenario's 5.6 per cent is a full percentage point above that – an increase equivalent in size to four moves of 25 basis points. Higher rates feed directly into variable-rate repayments.

What the model found

The headline output is the share of mortgagors at higher risk of defaulting: around 5 per cent in the scenario. Two qualifications sit alongside it in the Review.

  • The result is only a little higher than the 2023 peak, so even a severe combined shock produces a level of risk not far from one the system has recently experienced.
  • About two-thirds of the higher-risk group would still have buffers to service their debts for at least six months, which gives time for borrowers and lenders to respond before payments are missed.

The scenario starts from a position the RBA describes as solid. The FSR found the share of variable-rate owner-occupier borrowers in cash-flow shortfall "remains relatively low at around 2 per cent", the median borrower could cover "over a year of scheduled mortgage payments at current interest rates" from offset and redraw buffers, and "less than 1 per cent of borrowers" owe more than their property is worth.

How to read a stress test

It is important to be clear about what a stress test is not. It is not a prediction, and it does not signal what the RBA expects or intends to do with interest rates. Its purpose is to ask how the system would hold up if several things went wrong together.

The RBA's central view is quite different from the scenario. In its August Statement on Monetary Policy, it forecast GDP growth of 1.4 per cent over the year to December 2026. Asked about recession at her 29 September media conference, Bullock said: "That is not our central base case at this moment."

The Board has, however, kept the door open to further increases. Its September statement said it "will continue to do what it considers necessary to bring inflation sustainably back to target, including increasing the cash rate target further if needed." That is a statement of approach, not a commitment to any particular path.

Stress tests also look at the system rather than individual households. Assistant Governor (Economic) Sarah Hunter said on 22 September that she saw no signs of systemic financial distress, though individuals can struggle if their income changes. A borrower who loses a job faces their own version of the stress scenario, whatever the national numbers show.

The RBA's wider assessment also covered lenders. The Review concluded that "Australian banks are well positioned to continue lending, even in a downturn", which matters because a banking system that keeps lending can cushion rather than amplify a shock.

The bottom line

The RBA's severe scenario combines unemployment of 6.3 per cent, inflation of 7 per cent and a cash rate of 5.6 per cent – each well above current levels. Under those conditions, the share of mortgagors at higher risk of default rises to around 5 per cent, only a little above the 2023 peak, with about two-thirds of that group still holding at least six months of buffers.

The result supports the FSR's broader conclusion that "Most Australian households with mortgages remain well placed to manage more difficult conditions". What to watch: the 28 October CPI release, the Board's decision and new forecasts on 3 November, and the path of unemployment, the factor the scenario stresses hardest.