www.nicholsoncartoons.com.au 24th September 2004 - Reserve Bank warns on debt levels

There is no doubt about it - Household debt is spiraling out of control. The main driver appears to be the 25:1 liquid oxygen and kerosene propelled rocket placed under the housing sector. This in turn has fueled consumer confidence and with consumer confidence, comes consumer spending, lots of it and all powered by the plastic. In the ’80s the average Australian household had debts totaling around 40% of their disposal income, that is income after tax. In December 1986 the ratio was 44.1% and just twenty years later in December 2006 the ratio has accelerated to 158%, an increase of 258%. It is no wonder a 0.25% increase in interest rates feel a lot more these days. One should note that over this time, wages, hence disposal income has also increased and inflation has little, if any role to play with this.

It is interesting to view Australia’s household debt to income ratios with that of the United States after the collapse of the US subprime mortgage market in the first quarter of 2007. It appears to be an issue of quality vs quantity. While the USA may of had lower quality loans and lower lending standards, it appears Aussies have more debt which is accelerating so fast, it has left our US counterparts for dead.

You can follow more of the US subprime mortgage market collapse at the Mortgage Lender Implode-o-meter.

With more and more twenty somethings still living at home, the Baby boomers can’t help make cheap remarks, that “in my day we had Interest rates in the high tens of percent, today interest rates have never been lower”. But does the argument hold any truth?

The graph below shows interest payments as a percentage of household disposal income. The blue line shows mortgage repayments, while the red line shows total interest payments (credit cards, personal loans, mortgages etc.) The faint grey line is the standard bank mortgage rate over the same period. When interest rates peaked in 1989-90, roughly 9% of the average Australian disposable income was being used to service your debts. Today, even with rates so low 11.7% of your income is used to service your debts, an increase of 30%.

It is clear that housing asset prices have had a role in this. In 1989-90, about 6% of your wages were tucked away to service the mortgage. Today, it is closer to 9.3%, a increase of 55%. With the probability of rates rising and the effects of negative equity in housing markets such as Sydney where the ABS reports in the three years to December 2006 house prices fell an average of 8.8 per cent, I can tell you I would have much rather get a mortgage in 1989 than at present. At least in 1989, asset prices were reasonable so you could expect them to appreciate while you knew interest rates would never stay at those levels for the life of the loan.