Are Aussies up for another credit tightening?

Recent figures from the Australian Bureau of Statistics also show that the median value of debt held against owner-occupied dwellings was $102,600, compared with a median debt level of $5,000 for student loans, $3,000 on credit cards and $3,700 on car loans.

Over the past decade, the ratio of household debt to income saw most of the growth aligned with the property boom between late 2012 and 2017.

Further, the value of assets held against the debt has recorded a more significant increase, pushing household net worth to new record highs at the end of 2019. Residential dwellings comprise the largest component of household assets, totaling $6.8 trillion or 53 per cent of household wealth.

According to CoreLogic research director Tim Lawless, household debt levels should be monitored for two reasons: the household’s vulnerability to unexpected lifestyle changes and the implications to household savings.

“Heavily indebted households are generally more vulnerable to a ‘shock’ such as job loss, illness or a sharp rise in the cost of debt, which in turn has implications for financial stability,” he said.

“The other key area of concern relates to household spending; heavily indebted households may be more likely to save, rather than spend, during periods of uncertainty or economic hardship. With around 60 per cent of Australia’s economy dependent on household consumption, a sustained drop in spending activity would have a negative impact on economic growth,” Mr Lawless said.

Minimising risk

While household debt is high, and potentially a concern for consumption, servicing debt is at its most affordable since 1999 due to record-low interest rates, the research found.

The ratio of housing interest payments to household disposable income has more than halved since 2008, from a high of 13.3 per cent to 6.4 per cent in June 2020. With interest rates moving lower since June, the ratio is likely to fall even further.

Another factor helping to minimise risk is the fact that asset values are substantially higher than the debt held against them, Mr Lawless highlighted.

“The ratio of household debt to household assets was 19.4 per cent and the ratio of housing debt to housing assets was 28.2 per cent in June 2020, implying a remarkably large amount of equity is held within the household sector.”

Credit policy and less consumer appetite for credit also help in alleviating risk associated with high household debt.

In June 2020, 9.2 per cent of home loans originated with a deposit of 10 per cent or less, down from a recent peak of 22 per cent in 2009. Similarly, interest-only loans comprised almost 46 per cent of new home loans in mid-2015, but have averaged only 17 per cent of new lending since mid-2017.

Additionally, loans with a high loan-to-income ratio have remained low, with June data showing only 5.8 per cent of new home loans were originated with a loan-to-income ratio of 6 per cent or higher.

“Lending standards have improved over the past five to 10 years, with a trend towards fewer loans originating with a high loan-to-valuation ratio and substantially fewer interest-only loans,” according to Mr Lawless.

“It is clear that households became more risk-averse through the worst of the COVID period.”

Household savings

National accounts data showed the household saving ratio skyrocketed to almost 20 per cent through the September and June quarters, reaching new highs in the three months to September.

“Given that the virus curve has [largely] flattened and consumer sentiment surged in recent months, it is likely the saving ratio will drop,” Mr Lawless suggested, however.

Additionally, the trend in personal credit, which has been in negative monthly growth territory since late 2019, has plummeted since March.

Moving forward

While risks associated with high household debt are manageable at the moment, the expected rise in interest rates could negatively impact recovery, CoreLogic suggested.

“As debt servicing costs move higher, a heavily indebted household sector would need to devote more of their income towards servicing debt and less to spending, which implies a medium-to-long-term risk to household spending.

“This implies high debt levels may also stagger and slow an economic recovery. If increases in housing debt servicing costs result from higher interest rates, the exacerbated drag on spending could slow economic growth..

“Additionally, with household debt remaining high, the sector is more exposed to unforeseen events such as job loss and illness, as well as black swan events like a pandemic or financial crisis,” Mr Lawless explained.

According to CoreLogic’s research director, policymakers and regulators are likely to be on the watch for any signs of rising household debt or slippage in lending standards that could lead to higher household debt. 

Ultimately, higher loan-to-value lending or higher loan-to-income ratios could be the trigger for a new round of macro-prudential style intervention, as has recently been the case in New Zealand.

“Recent macro-prudential interventions targeted interest-only lending and growth in lending for investment housing through 2014 and 2019. 

“Future interventions may be aimed at keeping a lid on household debt levels and minimising longer-term risk via firm limits on loan-to-valuation ratios, loan-to-income ratios or debt-to-income ratios,” Mr Lawless concluded.

These risks were recently covered in detail by the RBA during a standing committee on economics hearing.

Earlier this month, the governor of the Reserve Bank of Australia (RBA), Philip Lowe, was asked by the standing committee on economics whether Australia would follow suit and intervene if it was concerned by house price volatility.

Speaking at the time, Mr Lowe said that while he had been concerned about volatility and the risk of “very large declines” in house prices “earlier in the year”, this was largely when forecasts were looking at the prospect of unemployment reaching over 10 per cent, output falling by 10 per cent and population growth stopping at zero.

Noting that this would have undermined community confidence and “cause problems for the banking system”, he added that he was “not particularly concerned” about housing prices at the moment. 

In separate analysis from the latest Financial Stability Review, the RBA noted that only 3 per cent of Australian mortgages are thought to be in negative equity. The risks associated with high household debt levels weighing on consumption are more substantial, especially under a scenario where housing prices fell.

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