Excessive mortgages have been granted to people who may not be able to pay them back. This is why this is bad news for Australia.
No more mega-loans, okay? The Reserve Bank of Australia is seeing more and more normal people taking on mountains of really heroic debt, and it gets very nervous.
The 22-year-old teacher with the million dollar mortgage? The couple with a house they haven’t paid a dime who now gets more funding for a beach house? The guy with the leased BMW and the highly leveraged real estate portfolio? All of these people are in the crosshairs.
“There is a risk of excessive borrowing due to low interest rates and rising house prices,” the RBA said in a new report released Friday that foreshadowed further real estate crackdowns in to come.
The Reserve Bank keeps an eye on the real estate market because it wants to avoid a real estate collapse. Australia hasn’t seen a recent event like Ireland or America where house prices are crashing and that makes an economy even weaker. They want it to be that way, and the best way to make sure that doesn’t happen is to keep the problem from getting too out of hand in the first place.
People suddenly borrow more than six times their income, the RBA found. Although fewer people borrow more than 90 percent of their home’s value (LVR> 90), debt-to-income ratios (DTIs) above six are rising rapidly, as shown in the following chart. This means that more and more people are borrowing more than $ 600,000 on an income of $ 100,000.
(LVR stands for Loan-to-Value Ratio. Borrowing $ 900,000 on a million dollar house is LVR of 90. ADI stands for Authorized Depository Institution and this refers to banks DTI is Debt to-Income.)
In this time of pathetic income growth and ultra-low mortgage rates, does it make sense that mortgages are increasing so quickly? Or does it just put us at risk in the event that rates go up?
Of course, your million dollar mortgage can be barely manageable at 2% rates. You need to find $ 3,700 per month, assuming a 30-year loan on principal and interest. But if the rates hit 3%, the repayment is suddenly $ 4,200. For some households, this will push them to the limit.
And some people have bigger mortgages than that. In New South Wales, 40,000 households had monthly mortgage payments over $ 5,000 in 2016. That would be even higher now. Terrible.
The reason the RBA cares about people with high income debt is that these people are the group most likely to find themselves in mortgage stress. If there is a recession, people who owe a lot of money will likely stop spending on everyday items and make any recession even worse.
Obviously, Australians are borrowing a lot more these days, and the main reason is the level of mortgage interest rates. The rates are cheap as shown in the following graph! You can borrow to buy a home at interest rates as low as 2% per annum. This means that borrowing huge sums is much more affordable.
The RBA has set very low official interest rates to speed up economic growth and avoid recession, and one effect of low rates is to stimulate the housing market. Shouldn’t they just raise interest rates if they don’t want house prices to go up? The answer is… maybe not.
Why not just increase the interest rates?
Low interest rates also lower our dollar, which makes it easier for our exporters. And they allow businesses to borrow money to grow their businesses at a lower cost. This is useful, because growing businesses hire more workers and reduce the unemployment rate. Raising interest rates is therefore straightforward and would reduce risk in the housing market, but it would lead to unwanted side effects.
Enter macroprudential policy.
Macroprudential policy is what you do when you want the housing market to cool down but can’t risk raising interest rates.
The government has already introduced a new macroprudential rule in an attempt to cool the housing market. As of last week, banks have to assess your repayment capacity if rates go up 3%, not just if rates go up 2.5%.
This change means that people can borrow about 5% less. This could in theory cool the market, but in reality very few people are borrowing to their limit (people who are mostly first-time home buyers – they will be hit the hardest by this rule change.)
What is most likely to happen is for the unstoppable momentum in the Australian property market to continue, blowing through the rule change like a Mack truck through a stack of boxes.
The RBA says the recent rule change will take a few months to affect the housing market, but admits that after that “the parameters may need to be adjusted.”
So this is not the end. The new RBA report includes a menu of other ways to crack down on the housing market, examining the macroprudential rules used in Canada, Norway, New Zealand, Ireland and more. Their menu of options includes limits on loan-to-value ratios, for example, so you can’t borrow more than 90 percent of the value of a new home. It also includes limits on the borrowing of investors.
If the housing market continues to advance – and it likely will – brace for more crackdown just before Christmas.
Jason Murphy is an economist | @jasemurphy. He is the author of the book Incentivology.