Soaring household debt poses risks to economy: AHURI

Household debt and an increase in income-to-debt ratios add to macro-economic risks, suggests new research.

The study by researchers from the University of Sydney for the Australian Housing and Urban Research Institute reveals how the housing market is one contributing factor to these macro-economic risks. 

Titled ‘Housing prices, household debt and consumer spending’, the study examined the effects of house prices and house-price-induced increases in debt on general consumption spending in Australia, focusing specifically on how such links were affected by the GFC.

The study suggests that policymakers should consider the potential risks that high levels of household debt and rising household income-to-debt ratios bring to the economy.

It points to the dangers, saying a number of countries have regulations that “limit the growth of household indebtedness, while the need to ensure robust prudential regulation remains an important policy priority”.

The study identified the consumption patterns for homeowners and home owning investors at different ages and who had greater or smaller amounts of debt or equity in their properties. 

Before the GFC, a rise in housing prices were associated with increases in consumption (i.e. spending or borrowing) for homeowners, particularly because they borrowed a larger fraction of the property price (i.e. had a higher ‘Loan to Value’ (LTV) ratio). 

However, after the GFC households with high LTVs turned more conservative and were no longer increasing their debt to increase consumption as a response to increases in house prices, the research noted.

“Our findings are relevant for macro-economic stability in Australia,” says associate professor Stephen Whelan, from the University of Sydney," it said.

“In particular, the finding that households with higher levels of debt are most responsive to increases in house prices highlights a potential systemic risk. Financing higher consumption through taking debt among highly leveraged households exposes those households to the risk of significant loss if house prices fall or if interest rates rise. This is in contrast to a general belief in Australia that debt is held by those most able to service it, namely, higher income and higher wealth households.

"Before the GFC, for every $100,000 increase in house values old-aged households increased their consumption by $1,000 per year and middle-aged households increased consumption by $1,700. After the GFC, consumption by old- and middle-aged households dropped to $600 and $1,600 per year respectively.

"The significance of this is seen if we consider there are 1.69 million households aged 65 and over who are homeowners (90% of these households do not own another property), then just $400 less being consumed each year by each household means a loss to the economy of approximately $608 million when compared to pre-GFC household consumption."

The report also finds differences in the consumption responses of home owning investors with and without debt.

Following the GFC, home owning investors with no debt became more conservative, reducing their consumption response from around $3,000 to approximately $2,600 per annum for every $100,000 increase in house prices. Whereas investors with mortgage debt became more responsive as their consumption response rose from $1,700 per annum to almost $2,900 per annum for a $100,000 increase in house prices.

The conclusion of this finding was that these investors with mortgage debt are not as risk-adverse when compared to other homeowners.