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The Australian debt crisis: Trapped in the vicious cycle of home loans

The Australian debt crisis: Trapped in the vicious cycle of home loans

By Aakash Sinha

While the world is busy wrapping its head around Donald Trump’s involvement with Russia in rigging the U.S. elections, another crisis seems to be forming in the Southern hemisphere—the Australian housing debt crisis. The phrase ‘housing debt crisis’, invokes the mention of the global financial crisis (GFC) of 2008, which rendered thousands of people jobless, homeless and bankrupt.

Long history of debt crises

Australia had somehow survived the 2008 crisis because of China’s package which involved purchasing minerals from them. In 2008, trade between Australia and China rose to $78.1 billion at a rate of 15.6%. Driven by demand for resources and energy, the growth of exports far exceeded the growth in imports into Australia. The balance of trade swung in favour of Australia which recorded a trade surplus with China ($6.6 billion) for the first time. Thus, Australia survived the GFC unscathed.

However, Australia faces serious peril right now. The Australian median home prices between 2009-2017 rose by 99.4%. This would not be worrisome if the wages had also increased at a similar rate. But wages from 2009–2017 rose by a mere 13.5%. The difference is unimaginable. 

The housing debt menace

The property price surge renders the current Australian generation helpless. Hence, they are turning to housing loans as it is the only option available. Moreover, low rates of interest along with minimal regulations increased the housing loan borrowings at a tremendous rate. 

Another factor which helped in the booming of the housing debt market is the availability of interest-only home loans. This means that the borrower only pays interest on the mortgage through monthly payments for a fixed term—generally between 5-7 years. After the term is over, people refinance their homes, make a lump-sum payment, or begin paying off the principal of the loan. However, when paying the principal, costs significantly increase. The absence of initial principal payment lured people into carelessly taking household loans without any significant increase in their wages.

Currently, Australia’s ratio of household debt as a percentage of net disposable income stands at 212%. According to the Organisation for Economic Co-operation and Development, it is the fourth highest in the world. Sydney’s house prices are ten times the average income. Due to such high spending on household debt, less money is available for discretionary spending. Small and medium scale businesses suffer the most, contributing to sluggish growth, unemployment and stagnant wage rates.

Damage control: Tough times ahead

However, the Reserve Bank of Australia (RBA) has finally recognised the big mess it helped create. It has proposed to increase the cash rates from 2% to 3.5%. An increase in cash rate will lead to an increase in the cost of borrowing for banks. Banks will then recover these costs by making loans for common citizens costlier. This will drive down the demand for housing loans and will make the existing loans much costlier.

Further, all this would send the average mortgage rate from 5.25% to 7.25%. For a mortgage of $400,000, that would equate to paying an extra $522 a month. Since most of the Australian home loans are adjustable, interest-only loans would be the ones taking a major hit. Because wages have not grown in the same proportion as the loans, situations where borrowers cannot make payments on loans are likely.

Earlier, borrowers would generally refinance the loan at the end of the interest paying period and this would go on indefinitely. However, now they will have to make principal repayments right after the interest payments. Tightening of regulations and higher interest rates would lead to delinquency which would further affect the demand for houses. Due to the high-interest rates, this would result in a reduction in loan supply. Finally, with an abundant supply of houses and a stunted demand, the prices are likely to tumble down.

Featured Image Source: Flickr

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