Everybody knows that borrowing too much is dangerous.
The problem is that for around a decade those who borrowed to the max and beyond to buy property have actually won big for their bravery.
Banks and other financial institutions absolutely loved these fearless borrowers and were happy to turn a blind eye to the extent of their overall debt, as long as they made the repayments.
A few of these big borrowers fell over but on the whole their risk paid off – property prices rose faster than their debts due to low interest rates, meaning that a revaluation increased their equity in the property.
Savers slammed while borrowers rewarded
Meanwhile those more risk averse individuals who continued to save rather than borrow too much were losers, watching property prices rise faster than they could keep up with.
Australia’s property boom lasted for so long that reckless borrowing became entrenched on the lending and borrowing sides and literally became a way of life.
Now, the switch has finally and decisively been flicked on the fearless borrowers and the fearless lenders and the chickens are really coming home to roost.
With property prices stagnant at best and falling in some of the major property markets of Melbourne and Sydney, the revaluation game has come to an end.
Just this week a report found that most economists believe that the Sydney market in particular will remain weak until 2020 at the earliest.
Revaluation game over, interest only loans difficult to get
In fact a revaluation is now the last thing a big borrower wants – it will actually make matters worse and could lead to a request for extra capital rather than allowing more borrowings.
Interest only loans – long the number one choice of property investors who wanted to minimise loan repayments and maximise negative gearing interest deductions – are now being greatly curtailed, meaning that many fearless borrowers who need to refinance at the end of a loan term are being forced to move to traditional principal and interest loans with much higher repayments.
RBA concerned about preparedness for economic shock
The potential for this problem to worsen so much that it impacts on Australia’s retail spending and economic growth has long been worrying the collective minds of the Reserve Bank.
RBA governor Philip Lowe has warned that the combination of Australia’s housing obsession, low interest rates and financial deregulation has led Australia’s household debt to among the highest on the world and has left the entire country vulnerable to an economic shock.
The RBA board has repeatedly voiced concerns that household debt could be a barrier to recovery if economic conditions deteriorate and that even cutting interest rates from their current record low of 1.5 per cent would have less of an effect on stimulating spending for highly-indebted households.
Lower rates won’t be an answer
The RBA said the next move “in the cash rate would more likely be an increase than a decrease” but that move could be quite some time way, after the RBA left the cash rate unchanged for the 21st consecutive meeting in July.
It found household debt has increased by more than household income over the preceding three decades in many countries, but particularly in Australia.
“Households with high debt levels are more vulnerable to economic shocks and therefore more likely to reduce consumption in the face of uncertainty about their future income,” the RBA board said in their minutes.
“Changes in interest rates have a larger effect on disposable income for households with high debt levels, but these households may be less inclined to borrow more at times when interest rates fall.”
Big houses and low wage growth a toxic combination
The RBA said Australia’s relatively high ownership of large detached houses in urban centres has driven the rise in debt levels to record highs, but that the major markets of Sydney and Melbourne were now seeing falling prices.
“Housing prices had fallen by almost 5 per cent in Sydney over the preceding year.”
At the same time wages growth has been very low which has been of very little help to those with high mortgages.
Also not helping is a spate of out of cycle interest rate rises from some of the smaller banks – particularly for investor housing loans – with fears that it is only a matter of time until the big four banks start to pass on their increased funding costs on to borrowers.
With the gathering storm clouds around world trade continuing to gain pace, the RBA are not alone in being concerned that Australia’s fearless borrowers could land all of us in hot water should that big economic shock arrive soon.