Australians are spending more on debt than much of the western world –and we’re digging ourselves deeper into a hole while others improve.
Of 17 highly developed countries, Australian households ranked third for income spent on debt repayments, the Bank for International Settlements, the central bank of central banks, reported on September 16.
The average Australian household spent 15.1 per cent of income on interest and principal repayments (a measure known as the ‘debt service ratio’) in January-March 2016, according to BIS.
This was more than Canada (12.3), the United Kingdom (9.7), the United States (8.2), Japan (7.4), Germany (6.4) and France (6.2).
It confirms we are increasingly indebted, and that our wages are not growing enough to keep up with that increase. Only the Netherlands (17.8) and Denmark (15.3) had higher rates.
Dr Timo Henckel, a senior economist at the Australian National University, told The New Daily the “concerning” measure was attributable to record low interest rates.
“The issue with leverage is that leverage cycles always last a lot longer than people think. I’m the first to admit that I get caught out and surprised at how long a sector can pile up debt and leverage itself before it unwinds.”
Readers will note that 15.1 per cent of income sounds too low. This is because it is an average figure. A household with a mortgage, a car loan and two credit cards is probably spending far more than the average.
The measure supports existing data. As The New Daily reported last week, Australian household debt is now 125 per cent of the nation’s gross domestic product (GDP), compared to about half in 1990.
As explained by Dr Henckel, this enormous debt burden gives rise to two big risks.
1. The rate risk
Because about 85 per cent of Australian debt is home loans, this is primarily a story about the property market, where prices have risen steadily because of record low interest rates.
Australia’s current debt service ratio is much lower than the 18.1 per cent high of 2008. But according to Dr Henckel, our upward trajectory (we gained 30 basis points between September 2015 and January 2016) is worrying because of the risk of rising interest rates.
It is the concern of many economists, Dr Henckel included, that when the Reserve Bank eventually lifts the official cash rate, it will hurt many highly-leverage households stocked up on mortgages, credit cards, car loans and more.
An example is the pain felt by households before and during the global financial crisis, when the number of households at risk of mortgage default peaked at 32.7 per cent in May 2008. This was partly because the RBA had been ramping up rates to fight inflation caused by the commodities boom. This figure is currently 17.4 per cent.
2. The job risk
Dr Henckel said another potential “crack in the system” is unemployment. “As soon as households lose jobs, the unemployment rate increases, and it can unwind pretty quickly.”
Another set of data, also released this week, illustrates this point. More than two-thirds of owner-occupied mortgages are now held by households with two incomes, Roy Morgan reported on Monday.
A third (34.8 per cent) of these dual-income households would become at risk of default if even the non-main earner dropped out of the workforce, the research firm estimated.
This was confirmed by Financial Counselling Australia CEO Fiona Guthrie, who told The New Daily last week that job loss, not an increase in interest rates, is the shock of most importance to many households.
Two potential ways to protect yourself are:
- Income insurance. The Association of Superannuation Funds (ASFA) said it is “always a good idea” to consider tailoring the insurance coverage provided by your super fund to protect against lost income. “A phone call to your superannuation fund is a great place to start.”
- A rainy day fund. Many experts recommend building a savings account to hedge against the risk of rising rates, reduced income and other financial shocks. A budgeting strategy to reduce expenses and increase savings is a good start.
The potential good news
Rising household debt may be more of a threat to individuals than it is to the Australian economy as a whole, according to the Reserve Bank.
A study conducted by the RBA in 2015 found that while household debt is rising, it is “concentrated among households that are well placed to service it”.
Thus, aggregate measures of household indebtedness may be “misleading indicators of the household sector’s financial fragility”, the report found.
Put simply, it may be the wealthiest households that are taking on the most debt, with the potential to skew data like that released by the Bank for International Settlements.