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The truth about our debt

Personal debt

Much is being made of the record level of household debt in Australia.  The media is full of stories screaming about the risks of debt for the economy.

Household debt has risen from levels equivalent to around 75 per cent of annual household disposable income in the mid 1990s to close to 200 per cent today and it is an issue that sparks fears of a crash, the next recession or something equally frightening.

Debt is high, for sure, but for anyone who undertakes sober and factual analysis of the household debt issue and judges the overall financial position of the household sector and not just debt, there is little to be worried about.

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It is vitally important to realise that households do not take on that debt and throw the cash away. On the contrary.

Debt is used to buy assets which includes things like housing, commercial property and shares. For the bulk of the population with little or no debt, they are coincidently squirrelling away their savings and are accumulating wealth.

According to the latest data complied by the RBA, household assets are growing very strongly, aided by a building up in savings, unrelenting growth in superannuation holdings, growth in bank deposits and of course, from rising house prices.

While household debt is indeed just under 200 per cent of disposable income, household holdings of financial assets, which includes superannuation, direct share holdings and deposits, is now over 400 per cent of income. This is up from around 200 per cent of income in the mid 1990s.

While it can and never will happen, this fact indicates that householders could ‘cash out’ their financial assets, pay off all their debt and still be left with a couple of trillion dollars or around 225 per cent of household disposable income in left over cash.

That is a sound start to analysing the household sector’s balance sheet and puts the kybosh on the ‘debt disaster’ we hear so much about.

Now let’s look at another part of the household sector’s balance sheet, assets in housing. The total value of housing in Australia is hovering around $7 trillion – yes trillion – which is over 500 per cent of disposable income. In the mid 1990s, this ratio was under 300 per cent. This wealth accumulation in housing has been phenomenal.

It means, quite simply, that while the household debt to income ratio has risen by around 125 percentage points over 25 years, assets in housing alone have risen around 225 per cent of household income.

When all household assets are tallied, they total just under 1,000 per cent of annual income, which looked at another way, is a multiple of 10.

This means that the net level of household wealth (total assets minus total liabilities) is currently just under 800 per cent of income. It has never been higher. Net assets have risen from around 450 per cent of income in the mid 1990s.

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Or another way, for every $1 of debt that the house sectors has, they have $5 of assets, which is a loan to value ratio of 20 per cent.

It is also important to note that the level of financial stress is low. Indeed, it has rarely been lower in the last 25 years than it is today.  Bad debts are a trivial proportion of bank liabilities, borrowers are comfortably meeting repayments and a huge proportion of mortgage holders are well ahead in their repayment schedule.

Suffice to say, the focus on household debt captures only part of the story of the risks to the economy. Substantial interest rates rises would hurt the economy, to be sure, but this is the very reason why such a policy outlook is not going to happen.

But while the asset side of the household balance sheet remains healthy, the debt side will remain a non-problem.