High household debt is nothing to worry about, says a new report from the Reserve Bank of Australia, which suggests incomes are sufficient to service the rising debt levels.

But the RBA has warned about the prospect of negative housing equity – whereby mortgage levels outstrip associated house prices – in some states and territories.

In its Financial Stability Review released this month, the RBA says Australian housing debt is generally well managed and largely held by higher income earners.

“Around three-quarters of the debt is owed by households in the top 40 per cent of the income distribution, who generally have a high capacity to make repayments and are less likely to experience sustained unemployment. These factors reduce the potential losses for lenders,” the RBA said.

And while household debt in Australia is around 190 per cent of household income, higher than in most other countries, most households are comfortably making their debt repayments, with the arrears rate low by international standards, the central bank said.

According to another recent report from Roy Morgan, the value of assets held by Australians has almost doubled from 2007 to 2019, faster than the increase in debt of 78.6 per cent over the same period.

As a result, net wealth is now 98.7 per cent higher in 2019 than it was in 2007. Average per capita net wealth after allowing for inflation is 28 per cent higher than it was in 2007.

Almost half of Australia’s personal wealth is held in the form of owner-occupied housing (49.8 per cent), down slightly from 51.6 per cent in 2007. Superannuation assets make up an increasingly high portion, rising from 19.2 per cent to 24.4 per cent of our wealth.

The following chart shows that the average personal assets are now worth 8.1 times average debts, compared with 7.4 times debts in 2007.

Asset growth has outpaced rising debt

debt levels

Source: Roy Morgan Single Source (Australia) 

Borrowing to invest still good idea

According to Craig James, chief economist for Commsec, borrowing to buy property still makes sense.

“Borrowing to buy assets like homes always represents an attractive strategy provided that the return on the asset exceeds any lift in debt servicing. And for most borrowers that is the case over time. The value of homes and shares has been increasing over time while borrowing rates have been falling,” says James.

“There are some exceptions. Relatively recent home borrowers in Western Australia have seen the value of their assets fall rather than rise. But provided that the asset owner hasn’t needed to sell, then it may just represent a paper loss.”

Recent interest rate cuts could boost spending power if borrowers refinance loans or they have extra confidence to spend because they are further ahead in repayments, James added.

Rise in non-performing loans, negative equity

However, the central bank noted that the rise in housing non-performing loans – those on which the debtor hasn't made scheduled payments for 90 days or more – to its highest level in several years is ‘’notable’’.

Rising unemployment or ongoing weakness in income growth could push struggling households struggle over the edge and make mortgage repayment difficult, if not impossible for a few households.

“With around one-third of households having mortgage debt, in aggregate this could result in a sizeable decline in consumption and so amplify any shock to the economy and so the financial system,” the RBA said.

The central bank noted that with property prices still falling in Western Australia and the Northern Territory, “the incidence of negative equity is rising.” A further 10 per cent fall in prices in these regions would see over one-third of these loan balances being associated with negative equity, or where the house that secures a mortgage is worth more than the debt itself.
However, the RBA believes the uptick in housing demand and prices in Sydney and Melbourne has reduced the risk that sustained falls in housing prices could lead to widespread negative equity. This could in turn flow on as losses for the major lenders.

Bank earnings under pressure

Stephen Miller, investment strategist with fund manager GSFM, says while high household debt on its own isn’t a problem, it will still be a restraint on Australia’s economic growth and big banks’ earnings, as it leaves less for household spending.

“I think this is the key explanation behind tepid growth in household spending and GDP growth. So, I do think the already high level of household debt will – other things equal – curtail household appetite for more debt…and accordingly mean bank earnings are less than they might otherwise be,” Miller says.

A bigger potential problem is that while debt is quite stable, asset prices are volatile. Any downdraft in the price of risk assets such as shares or property because of trade wars or political tensions could lead to more severe economic consequences.

Australia among leaders in household debt

Australia has the dubious distinction of having one of the highest household debt-to-GDP ratios in the world, second only to Switzerland in a Bank for International Settlements study of 43 countries over the first quarter 2019.

"In this scenario, bank earnings would take a big hit as households sought to sell assets to consolidate debt and, as I say, the consequences could be way more severe than we're currently experiencing," says Miller.