Debt burden to hit home owners hard

THE Reserve Bank of Australia’s move to raise official interest rates for the second time in a month could prove costly for the market’s most vulnerable sector.

The Federal Government’s first home buyer’s grant has attracted a number of what industry analysts refer to as ‘marginal home owners’ to the market.

A period of low interest rates has encouraged widespread borrowing, resulting in a higher level of household debt than 10 years ago.

Consequently, analysts report that small increases in the official interest rate hit consumers harder and faster, particularly buyers sitting at the margins of affordability.

Institute of Public Affairs executive director Dr Mike Nahan said the Reserve Bank took household debt into consideration when making adjustments to the official interest rate.

“Household debt has grown significantly over a number of years and that was clearly a concern of the Reserve Bank,” he said.

“And one of the reasons that people have gone into debt is the inflation in property prices.”

A trend towards gearing other investments off the family home also has encouraged borrowing, Dr Nahan said.

“There has been a large increase in renovating and new homes, and consequently the purchase of white goods and other household items,” he said.

The sectors that are most exposed to any upward shift in interest rates are the first-time buyers attracted to the market by the first home buyer’s grant, he said.

It’s the individuals sitting right at the margin who will find the added pressure of a rate rise very uncomfortable, Dr Nahan said.

“Affordability has been at record levels and the first home buyer’s grant has sucked in a whole range of people, including people at the margin of affordability,” he said.

“Half a percentage point [rise] will be enough to turf some people out.

“The average size of loans is also quite large and that is a concern and it will hit people.

“But I think the Reserve Bank is right. It will affect people at the margins, but inflation is bouncing against the agreed limits.”

It’s not just the first home owners who will feel the pinch, investors are also likely to leave the market in light of the upward shift of interest rates, according to Australand managing director Brendon Crotty.

In his speech for the recent Sir James McCusker Memorial Address, Mr Crotty said an interest rate increase of 0.75 per cent would not have a major impact on the demand for well-located property.

However, investors and first home buyers would drop out of the market and reduce underlying demand by about 10 to 15 per cent, he said.

The baby boomers are another active demographic in the market, and Mr Crotty said this group would continue to make decisions regarding property irrespective of interest rates settings.

Chamber of Commerce and Industry WA chief economist Nicky Cusworth said small interest rate changes had a bigger impact on households in the current climate because they were carrying more debt.

“A 0.25 per cent change has the same effect as, say, almost a 0.75 per cent adjustment almost a decade ago because there is more debt,” Ms Cusworth said.

“Having said that, it’s possible to get too alarmist and, although household debt has risen, assets have also increased.

“So the household balance sheet is looking healthier.”

The Reserve Bank is mindful that adjustments don’t need to be of the magnitude that they used to be, she said.

“The emphasis is on fewer adjustments that are very well signalled to the market,” Ms Cusworth said.

Hegney Property Valuations managing director Gavin Hegney said the level of household debt could be inflated by equity loans.

“The fastest growing loans are equity loans. I think this could be a bit misleading [in terms of the household debt figures],” he said.

“With the interest rate rise I feel the impact will be fairly minimal and very isolated.

“It will be isolated to the people who’ve bought property recently with the first home buyer’s grant.”

Mr Hegney said he felt investors were better placed to absorb any rate increase.

“When interest rates rise on the back of a robust property market it’s only the last ones in [buyers] who are really affected,” he said.