Be alert, not alarmed, about Australia's high household debt

Another day, another dire warning that Australian households are about to crumple under the crushing weight of debt.

The Chicken Littles of this world were set chirping last week by a special report by the International Monetary Fund, which today kicks off its annual meetings.

Central bankers from around the world, including Australia, are presently winging their way to Washington DC clutching copies of the special new analysis titled "Household Debt and Financial Stability".

The research was motivated by concern that despite the global financial crisis exposing the dangers of debt-fuelled growth, household debt across many advanced economies continues to rise a decade later.

Boffins at the fund crunched the numbers across 80 advanced and emerging economies to warn that the sugar hit to economic growth from higher household debt - through higher consumption - is followed, three to five years later, by the headache combination of lower growth and higher joblessness.

"Moreover, higher growth in household debt is associated with a greater probability of banking crisis," they found. And "these adverse effects are stronger when household debt is higher".

Scared? Don't be. At least, be alert, not alarmed.

Now, it's absolutely true that Australia's household debt to income ratio is one of the highest in the world. It's also true, and observed by the IMF in its paper, that richer countries are more able to service large household debts. To a large extent, high debt is more a marker of our wealth, not a portent of its doom.

As for the observation of a growth pay back - that is also less alarming than it sounds. The reason household debts have soared around the globe is that borrowing rates have plunged. When interest rates are low, households can afford to service much bigger debts.

In fact, this sugar hit and hangover are actually one of the ways in which monetary policy - the setting of interest rates by central banks - is specifically designed to work. It's got a fancy name: "intertemporal substitution" and it means bringing forward spending decisions.

It's also important to remember that the IMF analysis is simply an average of 80 countries. The true path of events for individual countries will vary according to local factors, such as "sound institutions, regulations and policies".

So, how are they holding up in Australia?

Again, there's no shortage of scary headlines, perhaps the most sensational of which in recent times come from the investment bank UBS and two reports on Australia's so-called "Liar Loans".

A survey by UBS of 907 recent mortgage recipients found firstly, that "in 2017 one-third of mortgage applications were not factual and accurate" and secondly, that "around one-third of interest only customers do not know or understand that they have taken out an interest only mortgage".

Bad news comes in thirds, it would seem.

But it seems the headline writers at UBS have got ahead of their own findings, somewhat.

On the first headline, what UBS' survey actually found was that 67 per cent of mortgage holders surveyed stated that their application was "completely factual and accurate". A further 25 per cent said it was "mostly factual and accurate", 8 per cent said "partially factual and accurate".

The basis for the second claim is that while interest only loans account for 35 per cent of all home loans, only 24 per cent of UBS' survey respondents said they had an interest only loan - ergo the rest must be stupid and a risk to the system.

Or, perhaps financial literacy is so low across the board, the result is not so surprising. Or maybe you have to be particularly wealthy to afford to be so blithely unaware of the specifics of your loan. Maybe people who have interest only loans, but also put extra savings into offset accounts don't consider themselves interest-only borrowers.

Overall, it really is a bridge too far to compare Australia's lending practices to the original "liar loans" - a term coined to describe the "stated income loans" which flourished in the US ahead of the GFC whereby borrowers were required to produce no proof of income to get a loan. They were a sister lending sin of the "NINJA loans" - "no income, no job and no assets" - which also took root.

In Australia, responsible lending laws require lenders to make "reasonable inquiries" about all borrowers' capacity to repay. While the precise meaning of this is not prescribed in law, our regulators issue regular instructions to lenders about what is expected, meaning that getting a loan here still requires a fair degree of hassle to produce payslips, credit card statements or utility bills.

Indeed, Westpac has only recently been hauled into court by the corporate watchdog for having relied on a "benchmark" of living expenses for different households to calculate borrowers' ability to repay - and not a more fine grained examination of their particular circumstances.

Outside the sensational UBS reports, it's hard to find much evidence that lending standards in Australia are in decline.

Mortgage defaults remain low and the proportion of loans that are genuinely "low-doc" has fallen dramatically, from about 8 per cent pre the GFC to around 1 per cent.

The share of loans written at above 90 per cent of a property's value has fallen.

It's true that competitive pricing on interest only loans has seen a rise in their use.

But, according to information provided by mortgage brokers to the Australian Securities and Investment Commission in 2016, 83 per cent of investors and 78 per cent of owner-occupiers on interest only loans earn more than $100,000 a year, compared to 64 per cent of investors and 60 per cent of owner-occupiers entering into principal and interest loans.

These borrowers may well feel a pinch when principal repayments kick in, but they're also, on average, in a better position to afford them.

This story Be alert, not alarmed, about Australia's high household debt first appeared on The Sydney Morning Herald.