Fretting about mortgage debt?

Australian households have experienced a spike in debt over the last two decades.
 
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01 .Growth in our debt

Mortgage debt

Households have experienced a substantial growth in debt in the last two decades. So how did we get here and what does it mean for us now?

CHOICE has found:

  • Debt-to-income ratio for Australian households has increased.
  • Banks are in an increasingly better position to make loans available to Australians – and they may even be more inclined to cut rates independently of the Reserve Bank of Australia.
  • If history is any guide, there’s plenty of reason to proceed with caution when it comes to borrowing money. Our high level of bank concentration could also pose a risk. We give our tips for minimising your mortgage debt.

 

Where’s the debt at?

Australian officialdom collects an array of statistics to provide insight into our changing lifestyles. The Reserve Bank of Australia (RBA), for example, publishes the Total Household Debt to Disposable Income ratio, which shows total household debt - essentially mortgages and consumer debt such as credit cards and car loans - as a percentage of annual income after tax for Australian households.

When the RBA records began in 1977, households had, on average, debt equal to roughly one-third of a yearly disposable income. In 1990, the ratio had risen to nearly half a yearly disposable income. Today, total household debt in Australia is equivalent to almost one-and-a-half years of disposable income.

Debt as a percentage of annual disposable income

Part of a global trend

This more than four-fold growth in our indebtedness is part of a global trend, with Australia near the top of the mortgage debt heap. Across the Western world, it seems our debt has been funding bigger houses, larger TVs and thinner iPads.

Our mortgages are the most significant proportion of this debt growth, comprising 133% of annual disposable income. In Australia, several contributing factors drive our mushrooming debt:

  • Financial deregulation In the 1980s, financial regulations were relaxed in many developed nations, leading to increased availability and variety of household loan products. Back in 2007 we looked at risky home loans such as 40-year mortgages and no-deposit home loans. Now, some lenders offer interest-only home loans with no fixed term. These loans can make home ownership look more affordable, but you end up paying more interest in the long term.
  • Lower interest rates Our increase in debt since the 1990s correlates to a reduction in the standard variable housing loan rate from 17% in 1990 to six per cent today. Other advanced economies such as NZ, UK, Canada, Germany and the US also experienced this pattern of falling interest rates.
  • Restricted urban housing supply By restraining the housing stock, housing growth management policies such as green belts and restricted land release can drive up house prices and therefore the debt required to purchase them.
  • Government incentives The First Home Owners Grant essentially enabled a bigger take-up in mortgage debt by providing or subsidising a deposit for first home buyers. It was first introduced in 1983 and then withdrawn, re-instated and increased over the past three decades. Economist Steve Keen has shown that each time it was re-instated or increased, the result was a boost in house prices. In turn, the tax incentive of negative gearing combined with increasing house prices encouraged investors into the market, which further increased house prices and housing debt.

Should you be worried?

In a 2010 speech, the RBA’s deputy governor noted that over the last decade households with the largest debts have also been those with the highest incomes – the top 40% of income earners in Australia hold 75% of the debt. In other words, most of our debt is in the hands of people who are most likely to be able to pay their debts.

Our borrowing has been fundamentally astute – lenders recommend your mortgage repayments should be no more than 35% of your gross income. This should leave you with enough to cover living costs and a buffer, should your circumstances change.

The RBA also highlights that the increase in household debt has been accompanied by an increase in financial assets held by households. So it concludes that despite our massive debt holdings we have the capacity to support this debt.

However the increase in financial assets held by households is partially driven by the increase in house prices over the past decade, meaning the value of our financial assets can be undone by downward movement in house prices. The RBA concedes that the high level of debt leaves us more vulnerable to economic shocks such as an increase in unemployment.

A report on housing debt by the IMF, prepared in the wake of what it refers to as the Great Recession – the global recession of 2009 that followed the 2007-2008 Global Financial Crisis (GFC) – warns that if high levels of debt are followed by a downturn in house prices, this will result in an even greater reduction in economic growth and therefore an increase in unemployment.

In other words, we should be concerned. On the one hand, we must reduce our debt so we’re less sensitive to changes in our economic circumstances. On the other, if the reduction in our debt levels leads to falling house prices we could accentuate an economic downturn.

Such a downturn in house prices has already been experienced by many of the countries that share our predilection for debt – the US market went bust in 2006, Ireland in 2007 and the UK in 2008. However, while other economies caught a nasty cold from the GFC, we simply took a pill and soldiered on, courtesy of booming commodity prices on the back of the juggernaut Chinese economy. Australia’s real house prices – that is, house prices adjusted for the inflation rate – faltered in 2009 and 2011, but they're on the up again. 

 
 

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Big four bonuses

big-four-banks-share

Australia’s big four banks have been the major beneficiaries of our record levels of mortgage debt. Not only did they avert the disasters that befell their international counterparts during the GFC, but they actually managed to increase their market share.

International agencies such as the IMF extol the performance and stability of the Australian banking sector. However, the IMF also warns that the high level of bank concentration could pose a risk. “The four major banks are systemically important, which means difficulties in any one of them would have severe repercussions for the financial system and the economy.”

But we don’t necessarily need the IMF to inform us of the costs involved in a highly concentrated banking system. The big four banks have been consistently failing to pass on RBA rate cuts to Australian mortgage holders, as CHOICE frequently highlights. The banks regularly cite wholesale funding and the increased cost of Australian resident deposits – that is, our bank accounts such as term deposits – as the reason for their inability to reduce lending rates, and in its March 2012 bulletin, the RBA supported the banks’ argument for increased funding costs.

However, as interest rates on our savings accounts have started to fall, the idea of the banks cutting lending rates independently of the RBA has been gaining momentum. Upon announcing another year of record profits, Commonwealth Bank chief executive Ian Navrev conceded that an independent rate cut is plausible, while UBS analyst Jonathan Mott says it is inevitable.

Several banks including Westpac, St. George and ME Bank have cut their fixed rate mortgages. However the headline grabber will be if one of the big banks drops its standard variable rate independently of the RBA. Small lender BMC Mortgage has led the way by cutting its standard variable rate by 0.1%.

Down with debt

australias-rate-of-saving

Australians haven’t been ignorant to the woes of the Western world, and we’ve been doing something about it.

We’ve been saving more and gradually reducing our debt levels. Since the height of the Great Recession, Australian households have been among the highest savers in the western world. Similarly, our total household debt has been gradually declining since its peak in 2006, and roughly half of Australian households are ahead on their mortgage payments, which is high compared to many other countries. The RBA estimates that Australian households are, on average, about one-and-a-half years ahead of scheduled repayments, which provides a significant buffer should our incomes take a hit.

Tips for reducing your mortgage debt

  • If everyone else’s interest rates are decreasing except for yours, ask your lender to match the best deal you can find. A 2010 CHOICE banking survey revealed about 60% of people who asked for a better deal on their home loan will get it.
  • If your interest rate falls, leave your repayments unchanged and reduce your loan with no extra effort.
  • Visit choice.com.au/money and moneysmart.gov.au for more mortgage tips.

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