Bubble Trouble What happens if home prices fall or rates rise?

The numbers are in and there’s sobering news about home prices and household debt, writes Harvey Grennan.

There has been much debate about whether Australia is in a housing bubble and, if so, when it will burst and how much values might decline. But even economists can’t decide whether we’re in a bubble, or even how to define it. We only really know one exists when it pops and the pain kicks in. For most of us, however, one rule is immutable: what goes up must eventually come down.

Recent statistics don’t paint a pretty picture of mortgage affordability. The latest international Demographia survey places Australia as the third most expensive urban housing market out of 406 across nine countries, with a median-priced house costing 5.5 times the median annual household income. (A figure of 5.1 and over is considered ‘severely unaffordable’.) A recent survey by CoreLogic puts the figure for Sydney at a record 9.8 times the median income.

Sydney house prices have jumped by 70 per cent in the past five years while average income growth has been just 13 per cent. Meanwhile, mortgage delinquencies increased in all eight Australian states and territories over the year to November 2016. Research firm Digital Finance Analytics has found that 23.4 per cent of households, including many in affluent areas such as Toorak and Bondi, are in ‘mortgage stress’, and estimates that almost 52,000 households will probably default on their mortgages in the next year.

According to the Reserve Bank, Australian household debt is now at record levels. One third of borrowers have little or no mortgage buffer if interest rates increase. Mortgage rates are currently at near-record lows of around 4.5 per cent, but back in 1989–90 they were 17 per cent. If interest rates were to climb to a more historically normal 8 per cent, on a principal-andinterest loan of $500,000 over 25 years, repayments would rise from $640 to $890 a week. That’s an increase of $250 a week. Imagine what that would do to the household budget, with energy and other costs already blowing out.

Although many are now paying more, 30 per cent of income has traditionally been considered the safe benchmark for mortgage repayments. Housing researcher Philip Soos of LF Economics believes this is no longer a good rule of thumb. “Sensible borrowers would factor in a sizeable margin, given the possibility that mortgage rates could – and are – rising,” he says.

“The other problem,” adds Soos,

“is that nominal wage growth is now at the lowest point since the end of World War II. With little wage growth to inflate away mortgage payments, many recent and over-leveraged borrowers will face considerable trouble in the foreseeable future. During the 1970s and ’80s, high wage growth inflated away debts even at high interest rates, so borrowers benefited. Today, this is not the case.”