Do rising house prices lead to risky borrowing?

With memories of the circumstances that led to the GFC, it might seem that current investors would be interested in reducing their debt and financial risks. However AHURI research reveals that property investors with mortgage debt increased their consumption (that is the amount they borrowed or spent) after the GFC from $2500 to over $2,800 per year for every $100,000 increase in their housing wealth, suggesting such investors are not as risk-averse as other homeowners.

The research, ‘Housing prices, household debt and consumer spending’, examined the effects of house price rises on household consumption before and after the GFC. It confirmed the wealth effect, where increases in house prices can have material impacts on the perception of wealth of a home owning household, and this can have downstream effects on consumption and therefore economic growth.

...the finding that households with higher levels of debt are most responsive to increases in house prices highlights a potential systemic risk... This is in contrast to a general belief in Australia that debt is held by those most able to service it, namely, higher income and higher wealth households.

‘Our findings are relevant for macro-economic stability in Australia,’ says Associate Professor Stephen Whelan from the University of Sydney. ‘In particular, the finding that households with higher levels of debt are most responsive to increases in house prices highlights a potential systemic risk. Financing higher consumption through taking debt among highly leveraged households exposes those households to the risk of significant loss if house prices fall or if interest rates rise. This is in contrast to a general belief in Australia that debt is held by those most able to service it, namely, higher income and higher wealth households.’

The researchers suggest macroeconomic policy-makers should acknowledge the potential risks associated with high levels of household debt and rising household income-to-debt ratios. In a number of countries with similar situations, regulations limit the growth of household indebtedness, while the need to ensure robust prudential regulation remains an important policy priority.

Nevertheless, for most home-owning households, the GFC had a moderating effect. Home owning property investors without mortgage debt reduced their annual consumption from around $3,000 for a $100,000 increase in house prices before the GFC to $2,600 for each $100,000 increase in house prices after the GFC.

Homeowners without investment properties also became more conservative. For example, older homeowners reduced their consumption by 40 per cent, from $1000 per year for each $100,000 increase down to $600 per year after the GFC. Scaling up these numbers to a national level reveals that if each of the 1.69 million households aged 65 and over who are homeowners (90% of whom do not own another property) consume just $400 less then that means a loss to the economy of approximately $608 million when compared to pre-GFC household consumption. (ABS 4130.0 Housing Occupancy and Costs, 2013–14. Tables 9 and 13.)