Cooling house prices – particularly in Sydney and Melbourne – may prompt astute existing and would-be homeowners to take a closer look at their household debt and its long-term impact on their personal finances.
When housing prices are rising, homebuyers are tempted to pay more to acquire their desired home, particularly at a time of historically-low interest rates. In turn, high housing prices have been a major contributor to Australian household debt reaching a historic high.
The ratio of household debt to income has risen by almost 30 percentage points over the past five years to reach almost 190 per cent, the Reserve Bank reports.
Adding to this is the so-called housing wealth effect. Research in both Australia and the United States, highlighted in the past by the Reserve Bank, shows that rising house prices can make us feel wealthier, encouraging us to spend more on consumer goods including new cars.
Lower housing prices mean that the pattern of chasing properties by paying higher prices should at least take a breather.
And depending on family circumstances, continuing low interest rates may provide an opportunity to reduce household debt. The Reserve Bank this month held the official cash rate at the record low of 1.5 per cent – a rate unaltered for almost two years.
High personal debt relative to income makes households not only more vulnerable to the impact of financial setbacks or future rate rises, but also disrupts their ability to save. The more money spent on non-deductible interest, the less money to invest in assets outside the valuable family home.
Further, as Smart Investing discusses from time to time, unpaid interest on credit card debt really compounds over time as interest becomes payable on interest – and this compounding accelerates when rates rise.
Another concern is rising “grey debt”, driven by a combination of low rates, high housing prices and an ageing population.
Research by the Australian Housing and Urban Research Institute at Curtin and RMIT universities, among others, confirms that growing numbers of homebuyers are carrying mortgage debt into retirement. This then demands the use of retirement income and savings to repay debt.
One of the smartest ways to prepare for a possible personal financial setback, (such as poor health, unemployment or marriage breakdown) and future rate rises, is to build up a mortgage buffer.
Prepayments of mortgages held in mortgage offset and redraw facilities in 2017 total about 19 per cent of outstanding owner-occupier mortgage debt, or two and a half years of repayments at current rates, the Reserve Bank reports. This reflects homebuyers taking advantage of low rates.
Yet while one-third of outstanding owner-occupier mortgages have at least a two years’ mortgage buffer, a quarter have less than a month.
Please contact us on |PHONE| if you seek further assistance.
Written by Robin Bowerman, Head of Market Strategy and Communications at Vanguard.
Reproduced with permission of Vanguard Investments Australia Ltd
Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer. We have not taken yours and your clients’ circumstances into account when preparing this material so it may not be applicable to the particular situation you are considering. You should consider your circumstances and our Product Disclosure Statement (PDS) or Prospectus before making any investment decision. You can access our PDS or Prospectus online or by calling us. This material was prepared in good faith and we accept no liability for any errors or omissions. Past performance is not an indication of future performance.
© 2018 Vanguard Investments Australia Ltd. All rights reserved.
Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee take any responsibility for any action or any service provided by the author.
Any links have been provided with permission for information purposes only and will take you to external websites, which are not connected to our company in any way. Note: Our company does not endorse and is not responsible for the accuracy of the contents/information contained within the linked site(s) accessible from this page.