Australian housing - when high debt meets falling prices

Despite signs the drop in house prices is slowing, there is still evidence that the number of households with stretched balance sheets are increasing, and that levered parts of the economy are due to large mortgages in comparison to incomes.

We recently showed how the basic maths of a A$1m loan actually costs in the region of A$4m pre-tax to pay off. This is clearly an enormous, and rather frightening, undertaking for any wage earner.

To follow up, we’ll look at the implications when there are large groups of people in a similar indebted situation, in a falling housing market.

The great Australian debt

Imagine a town of 100,000 people all took out a A$1m mortgage. Also imagine that wages are stagnant, and they’ve all borrowed about five to seven times their wage. They may have achieved the great Australian dream of owning a home, but they now have relatively high debt levels, and may be in a precarious situation should they hit a rough patch and need to borrow more money.

So, what happens if house prices fall, the economy weakens, and large segments of the population need to borrow money against their homes or refinance?

The sell-off

In prosperous times, when the economy and property markets are both performing well, access to credit tends to be easier, meaning refinancing a mortgage to trade up or take out equity in a property can be easily achieved.

However, in tougher times, credit and refinancing can be harder to come by, particularly when house prices fall below loan values creating negative equity. In such an environment, households become more cautious, and if mortgage holders lose their job or struggle to make repayments, there will be knock on effects to the rest of the economy.

When people experience one of these scenarios they may be forced to sell, causing more houses and liquidity to hit the market and prices to gap down. Should these issues happen in enough numbers, say, across a town of 100,000 people, the aggregate starts to move like a herd, and everyone rushes for the exit at the same time.

Should this happen over enough households, this is when the market officially enters a slump.

Tempering the fall

It’s for this reason that housing stimulus has become such a focus in Australia as the government and Reserve Bank of Australia (RBA) tries to engineer a soft landing after what has already been the largest fall in property prices since the early 1990s.

The stimulus is coming from four key areas:

1. Interest rate cuts, which have finally started to come through from the RBA with several more cuts priced into fixed income markets;
2. Tax cuts, which were announced in the Federal budget earlier this year and will now flow through beginning early in the 2019-20 financial year following the Coalition’s election win;
3. Housing policy stimulus, mainly aimed at helping first home buyers get into the market, such as lowering the amount of deposit they will need, and removing the requirement for lenders’ mortgage insurance; and
4. Credit stimulus, this is largely from the Australian Prudential Regulation Authority’s (APRA) proposed increase in the maximum borrowing capacity of creditors.

It is therefore good news on many levels that house price falls are slowing. Whether house prices can be sustained at these levels in the next few months, or even pushed higher again, is yet to be seen. However, at the very least, the change in momentum is welcome and certainly positive for the economy.