Housing crash unlikely, based on debt levels

By Dr Don Stammer - adviser to Altius Asset Management and columnist at The Australian. The views expressed are his own.

Predictions abound that Australian house prices will collapse, causing a banking crisis and economy-wide recession. And it’s mainly because of the mountain of household debt.

Of course, forecasts of an impending calamity in Australian housing are nothing new. One example was when gloom was widespread in 1989, when housing interest rates reached 17 per cent.

Another example was in 2010 when one of the world’s best-known economic commentators, Jeremy Grantham, the founder and head of a large US investment group, warned us that Australian house prices were a “time bomb … (it’s) only a matter of time before they crash … prices would need to come down by 42 per cent to return to the long-term trend”.

To be fair, Grantham later forecast that our house prices would fall slowly rather than plunge. Nonetheless, the median house price climbed more than 40 per cent in the seven years that followed.

I’ve long taken the view that the median house price here generally traces out a step-like path — moving sharply higher for a few years and then going sideways for an extended period.

Each boom in residential property brings financial pain to some households, mainly those who paid high prices late in the upswing, who borrowed very heavily, and who subsequently became unemployed or ill.

Also, prices in different suburbs, towns and regions swing more widely — and often at different times — than the median house price for the nation. Moreover, each boom has one or two new features; recently, there has been the big shift to interest-only mortgages and the increased role of overseas purchases of houses.

Past predictions for a housing crash so severe that the economy would be thrown into recession have all turned out to be excessive. Will it be different this time?

As the Australian Broadcasting Commission puts it:  “For every one dollar earned, on average, Australians have nearly two dollars of debt. We hold the dubious position of having the second-highest level of household debt.”

At the same time though, the level of bank deposits owned by households has surged. We’re likely to get a better picture of the housing outlook if we take into account both the gross debt and the net debt of households.

Deutsche Bank equity strategist Tim Baker points out that “household deposits can be thought of as being a buffer against a household’s debt levels (and is explicitly the case with home loan offset accounts)”.

Were all household deposits to be netted off, housing debt would drop from 200 per cent of income to 100 per cent. Of course, “there’s no ‘average’ household — households with a lot of deposits need not be households with a lot of debt. But the fact remains that a raw debt/income ratio overstates the extent of household leverage.”

In a couple of other ways, too, the finances of households in aggregate are less vulnerable than many naysayers believe.

Thanks to low interest rates, total interest payments on mortgages (at a tenth of household income), and the total of interest payments and repayments of principal (at a sixth of household income), are close to their long-term trends.

Clearly, our preference for variable rate borrowings means lenders can jack up the interest rates they charge on mortgages — meaning most borrowers face higher payments on their housing loans each time the Reserve Bank raises the cash rate.

At the same time, the predominance of variable loans reduces the risk the Reserve Bank will hike interest rates.

Unlike in the US, mortgages here allow the lender full recourse to the borrower. Largely as a result, banks’ write-off on their housing loan book hasn’t risen above 0.1 per cent of loans outstanding. In addition, about a third of households with mortgages are more than a year ahead on their repayments; and the earlier surge in house prices has given many households a better equity buffer in their mortgaged house.

The housing market is softening and there’s likely more weakening to come. But the housing outlook contains many shades of grey — it’s not enough to look at just the high level of gross debt.

Disclaimer: This article is not legal or personal financial advice and should not be relied on as such. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every reasonable care has been taken in distributing this article, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information contained within it. Any views expressed are those of the author(s) and do not represent the views of Australian Unity Personal Financial Services Ltd. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Taxation Information in this document should not be relied upon without seeking specialist advice from a tax professional. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in December 2018. © Copyright 2018