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Rising house prices are partly to blame for concerns from the International Monetary Fund about the rapid growth in Australia’s household debt.
The IMF issued the caution earlier this month, saying Australians were spending borrowed money at a “fast rate”, which would expose the country to future economic risk. “High private debt not only increases the likelihood of a financial crisis but can also hamper growth even in its absence, as highly indebted borrowers eventually decrease their consumption and investment,” says the IMF.
It is no surprise that Australian households are borrowing more. House prices keep increasing, requiring larger loans and credit cards continue to become the preferred method of payment for many. Interest rates are at their lowest ever, making borrowing cheaper than ever, while banks are keen to lend to borrowers in a bid to maximise their profits.
Should we be worried?
The IMF points out that in strong economic times, such as in Australia now, high levels of debt are not a problem. Australia continues to enjoy a low unemployment rate, meaning the majority of households are able to service their loans.
However, the situation becomes a little more risky if there is an economic downturn and people start to lose their jobs at a high rate, hampering their ability to pay back their loans.
The more debt people have incurred, the more pressure will be applied to the banking system if they can no longer pay them back. As we saw following the Global Financial Crisis, a banking system under pressure can lead to disastrous conditions for economies.
Closer to home, the Reserve Bank of Australia outlined in its recent Financial Stability Review that although it is more comfortable about where household debt levels are than they were six months ago, Australia’s household debt-to-income ratio continues to increase.
A major concern for the RBA is the state of the apartment market in Australian capital cities, particularly Brisbane and Melbourne CBDs. The amount of development taking place there is unprecedented and there are concerns about Australian banks’ exposure to this sector.
The RBA has calculated that the banks could lose up to $1 billion if prices were to drop by 45% for these apartments.
While such a price decline seems unlikely, the fact that banks could lose so much from a change in the performance of a relatively small part of the Australian property market shows how vulnerable they are to shocks.
The issue is that although economic conditions are pretty good in Australia right now, we have the lowest interest rates we have ever experienced. House prices continue to rise, which means borrowing to invest in property is a compelling option for some investors.
Have we struck the right balance?
Although monetary policy continues to be a major tool to drive economic growth, it is messing with housing markets, particularly house price growth as people can afford to borrow more.
As a result strategies to reduce household debt levels need to be employed. This is where banks and other lenders have a big role in moderating the amount they lend to households. The Australian Prudential Regulatory Authority has created guidelines to try to control debt levels, particularly to investors in residential property – considered to be the most risky part of the market.
The most recent proposal is to force residential mortgage lenders to get more information on borrowers’ incomes and expenses and to continue to make it harder for those wanting interest-only loans or to invest using their self-managed super funds to buy a residential property.
Most of the measures of lending behaviour are showing that these guidelines are working. While the average home loan increased 11.6% in 2015, year to date the average loan size has dropped by 2.7%. The share of new mortgages with loan to value ratios above 90% is at its lowest level since 2008.
These changes to how financial institutions are lending will lead to greater stability of our financial system and ultimately set Australia up to continue its impressive run of economic growth.