Every quarter, the Reserve Bank conducts their review of household finance data in which they examine the ratio of Australian household debts and assets to disposable income.
The latest review was recently released and it shows that the household debt to income ratio was at the record high of 193.7% as of Jun 2017.
Unsurprisingly, most of the household debt is related to the housing debt.
Is this alarming?
This number looks alarming as the debt to income ratio shows that your debt could be 197 times more than what you actually earn.
Let’s examine other ratios also published by RBA and put this number in perspective.
Other important ratios to consider as of June 2017
A) Household debt to assets ratio was at 20.7% and it has been falling since September 2011. This number means that your debt is 20% of your assets.
This number means that your debt is 20% of the value of your assets.
B) Housing Assets to income ratio was at the record high of 516%. This means your
In summary, both the value of our assets and the value of our liabilities have increased relative to our incomes.
Why has the debt to income ratio been increasing?
According to Philip Lowe, the governor of RBA, the reasons for the ratio to increase again over the past few years are as follows:
1. Lower interest rate
2. Slow growth in household income over the last 5 years
3. Some of our cities have become major global cities, and therefore more demand from overseas investors
4. Stronger population growth
Reasons 1,3 and 4 are strong indicators that the housing market will keep performing well because of the basic law of supply and demand.
Why has the housing price been increasing?
Governor Lowe summarized it for us in his speech.
We chose to borrow more for housing and this pushed up the average price of housing given the constraints on the supply side.
The supply of well-located housing and land in our cities has been constrained by a combination of zoning issues, geography and inadequate transport.
Another related factor was that our population was growing at a reasonable pace.
Adding to the picture, Australians consume more land per dwelling than is possible in many other countries, although this is changing, and many of us have chosen to live in a few large coastal cities.
Increased ability to borrow, more demand and constrained supply meant higher prices.
Is there a bubble?
So we saw marked increases in the ratios of housing prices and debt to household incomes up until the early 2000s.
At the time, there was much discussion as to whether these higher ratios were sustainable.
As things turned out, the higher ratios have been sustained for quite a while.
This largely reflects the choices we have made as a society regarding where and how we live (and how much at least some of us are prepared to spend to do so), urban planning and transport, and the nature of our financial system.
It is these choices that have underpinned the high level of housing prices.
So the changes that we have seen in these ratios are largely structural.
While it’s true that the increased debt puts pressure on all of us to keep up with the monthly repayment due to the slow growth in wages, the fundamentals of the housing market are still sound.
Looking long-term, financially, the key to creating wealth in property is your ability to manage cash flow.