It causes a heck of a lot less problems than booze, biscuits and cigarettes. Without it we’d probably still be living in primitive dwellings and getting from A to B on dirt roads via horse and cart. Among those who provide it are 4 of Australia’s 10 largest companies, our biggest employers.
Like a hammer to a builder, or a scalpel to a surgeon, it is a very valuable tool.
Yet some loathe it, some fear it, a few abuse it, plenty of people misunderstand it, and certain misery-gutses take delight in likening it to a ‘bomb’, a ‘binge’ or a ‘cliff’.
Truth be known, none of us particularly like having it. But 7 out of 10 dwellings are used as security it.
Personally, I think more appropriate comparisons are wine and chocolate – because they generate more good than bad.
The thing is, most important stuff in life costs lots of money. Debt enables us to use someone else’s money to make progress happen, to improve our lives, and to enjoy important things now, as opposed to years later (or not at all).
As always happens whenever property markets are performing strongly, there is currently much hullabaloo about the level of household debt in Australia. The commentary is an enormous storm-in-a-teacup and merely highlights some crappy attitudes amid a financially illiterate society.
For the record, the average Australian home loan in September 2021 was $574,427, and it is below $500,000 in 5 out of 8 states and lower again in when comparing regional locations to capital cities.
Yes, household debt increased by 60 percent over the decade ending June 2021, but household assets (aka ‘the benefits’) increased by much more. The average Australian household was 112 percent better off overall.
Seriously, where’s the bad in improvement and realising dreams?
Some of the current commentary has a ‘…look out, the bogeyman is coming to get you’ connotation. One could be confused of thinking everyone with a home loan has a house in Elm Street and Freddy Kruger as their neighbour.
It doesn’t help when the same few academics with a negative disposition and an abacus as their favourite toy get a rush from using a few select ratios to report reason for alarm. They are shadow-jumpers.
This month the Reserve Bank of Australia published an insightful research report titled The Rise of Household Liquidity. I personally read all 50-pages of it.
I note this key statement in the RBA report: It is common in the mainstream media, and even among academic research, to read that higher housing prices and debt over recent decades has made the economy more financially fragile. But it is less well known that, as part of this process of balance sheet expansion, the value of household liquid assets (which includes cash, deposits, equities and bonds) has also risen rapidly relative to incomes.”
Contrary to a few dramatic headlines, the below facts suggest that household finances in Australia have possibly never been healthier.
Moreover, I believe we are in the early stages of a new era that will be as prosperous as the post-war Baby-Boom era of the 1950’s (maybe even more prosperous).
DEBT-BOMB TALK IS TRASH
Whilst the voices of those in the tall-poppy and/or risk averse corners will grow increasingly louder over the next couple of years, the reality is that, with or without medium-term interest rate rises, there is significant surplus financial capacity within Australian households.
In their November 2021 report, the RBA said that “…our findings demonstrate that the decades-long expansion of household balance sheets does not necessarily mean that households have become overextended.”
A bunch of people hear the word ‘debt’ and immediately think ‘risk’ with very little understanding of the practicalities of borrower behaviour and the precautions in place.
People jump to conclusions such as ‘interest only’ or a loan-to-value ratio above 80 percent is ‘high risk’. Truth be known, risk is properly assessed through an individual borrower’s *overall* position, as opposed to the structure of one loan.
For example, plenty of borrowers elect to borrow 100 percent of the value of an investment property on an interest only loan structure. Many such borrowers also have a family home with considerable equity in it, access to a healthy reserve of cash in an offset account, and their debt structure is designed to accelerate principal reductions on their home loan. That’s responsible and smart, not ‘risky’ [Case Study].
According to the RBA, “…housing investors have the largest liquidity buffers among indebted households. The average housing investor has a liquidity buffer of around two years’ worth of income and is much less likely to be liquidity constrained than other households. Moreover, indebted investors that own multiple rental properties have even larger liquidity buffers on average.”
Below is a logical worst-case risk mitigation scenario to illustrate why ‘debt-bubble’ talk is nothing more than trash talk.
1) First Way Out (A Stable System)
For generations, Australia has held the mantle for having one of the most prudent credit policies in the world. Our banks are well capitalised and the assessment of a borrower’s credit application is incredibly conservative.
Banks require borrowers to have some of their own skin in the game. They often shade a borrower’s income, they exaggerate a borrower’s expenses, and they stress test interest expenses (a 2 percent interest rate buffer should be more than adequate, but APRA currently insists on an even bigger 3 percent buffer).
As a result, Australia has never experienced a widespread property market crash caused by debt – never!
The below chart shows that a lot has happened over the last 50-years – globally and nationally. The early 1990’s was arguably the toughest period since World War 1 and even then, with home loan interest rates nudging 17 percent, no property market crash occurred.
Current home loan interest rates are at record lows and, even if we get a handful of rate rises over the next few years, they’ll still be dirt-cheap. Any lemon-sucker suggestions of a ‘bubble’ is absolute baloney.
The volume of home loans in arrears by 30-days or more has been below 1.5 percent for decades and currently is a piddly 1.14 percent.
And the number of households in bankruptcy is only 0.16 percent and the trendline has been falling for many years.
2) Second Way Out (Income Security)
Frankly, the size of anyone’s debt is a supplementary consideration. The (very) small percentage of borrowers who ever get into significant trouble with debt has very little to do with how much debt they have, rather their ability to meet loan payments.
Job security is first base for a borrower’s ability to repay debt. A good national economy is therefore key to the critical mass of people’s ability to service it.
The current combined sum of factors which one can confidently assume about our economic future paints a positive picture.
At a macro level, Australia is fast approaching full employment for the first time in decades, wage growth prospects are rising with it, infrastructure investment is a record high, there’s lots of industry stimulus, and we have a record low volume of housing supply for sale and for rent.
3) Third Way Out (Borrower Discipline)
Household wages are a factor, but the fact that wages have not grown as much as house prices over these last two boom years is a moot point.
Real estate has never been a ‘simple equation’. For instance, the combined Australian capital city house price increased by 193 percent over the last 20-years, yet the average wage increased by 82 percent.
People don’t purchase real estate with cash – they make loan payments. The more relevant metric therefore is the relationship between the size of mortgage payments and the borrower’s income.
Only 4.7 percent of the average Australian household budget currently goes towards home loan interest expenses. That is the lowest ever in the 33-year history of RBA’s data series.
Someone with a $600,000 home loan is currently required to pay $6,000 per annum less than 2-years ago. Most Australian mortgage holders have been directing funds well above the minimum loan payment amount into offset and redraw accounts.
Earlier this month, RBA Assistant Governor Luci Ellis told a parliamentary committee that “…one important context here is, if and when rates do eventually rise, a lot of people will not actually need to raise their actual repayment, because they’re already paying more than they need to.”
4) Fourth Way Out (Liquidity)
The RBA report makes a very pertinent point about finance innovation post deregulation of Australian banks in the 1990’s, particularly with redraw facilities and offset accounts and how borrowers continually squirrel away hordes of cash.
RBA: “This increase in housing-related saving has been supported by the decline in interest rates and has allowed indebted households to build larger liquidity buffers. To the extent that more liquidity is associated with less financial stress, our results suggest that the higher ratio of debt to income has not made the household sector more financially fragile.”
Official RBA data confirms Australia’s 10.7 million households now have $1.296 billion in liquid assets. That is an enormous 106 percent more cash than a decade ago.
Moreover, Commonwealth Bank economist Gareth Aird suggests, when accounting for the large cash reserves sitting in redraws and offsets, Australian households would be sitting on a $230 billion in accumulated savings by the end of 2021.
That’s an enormous amount of ‘rainy-day money’.
“Overall, the rise in household liquidity appears to have increased the financial resilience of the household sector,” says RBA.
Stick that up your good-for-nothing ratios, like ‘household debt to household income.’
5) Fifth Way Out (Equity)
Pushed along by this current super-boom that commenced in Q4 2019, the value of many of Australia’s 10.7 million dwellings has increased by between 20 and 60 percent over the last 5-years [Australia’s Top 100 locations is listed here].
While 10,000 extra first-time buyers generally enter the market each month, most owners of residential property have been in the game for many years.
When all else fails, Australians don’t just throw in the towel and walk away from years of hard-earned money.
If each of the aforementioned first 4 risk mitigants all failed, selling the asset is an option. Whether one downsizes to a more affordable asset with a smaller debt or completely cashes out, the likelihood of incurring a net loss is extremely remote.
DEBT IS A VALUABLE TOOL
Real estate and debt go together like shiraz and wagyu.
Without debt, first-time buyers would never enter the property market, families would not be able to upgrade their homes and even the most motivated Australians would find it difficult to invest in their future.
Understand the risks, but debt is nothing to fear. The primary focus of debt should always be on the benefit associated with having taken it on.
The recent increase in the number of Australians upgrading their homes and investing in their future is a truly wonderful thing. Society should always encourage and support aspirations.
Those with a bad attitude who continually whack property investors are little more than tall-poppy brats. What’s not to admire about one who sets goals, is responsible and disciplined with their money, and chooses to pursue a future of independence?
The alternative to investing in one’s future is becoming an extra burden on the taxpayer purse (aka ‘joining the aged pension queue’) costing taxpayers $50 billion per year.
The current rental crisis – the worst in Australia’s 230-year history – is a consequence of a regulatory squeeze on debt that resulted in grossly insufficient investment. One can’t possibly expect to increase rental supply by consistently discouraging those who supply 98 percent of Australia’s rental stock.
ABOUT THE AUTHOR: Simon Pressley has spent his entire working life in formal roles on both sides of the household balance sheet. 20-years as a credit assessor, commercial lender and mortgage broker afforded him a strong appreciation for the good-and-bad of debt and a solid foundation for his last 15-years as a professional buyer of real estate assets and Australia’s premier property market analyst.
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