Borrowing boom casts long shadow

Household debt more than doubled during the property boom, leaving home-owners vulnerable when interest rates start rising again. Photo / Northern Advocate

How long, cold and dark a shadow will be cast by the big build-up of household debt over the past decade?

That is one of the fundamental judgment calls the Treasury will have had to make in drawing up the forecasts underpinning next week's Budget.

Household debt more than doubled in just six years, from $80 billion in 2001 - equivalent to 105 per cent of households' after-tax income - to $170 billion in 2007, or 156 per cent of income.

It has grown since then, but much more slowly: household debt rose by an average of 2.3 per cent a year over the past three years compared with an average 14 per cent a year from 2001 to 2007.

Relative to income, it has fallen a little - from its peak of 160 per cent in 2008 to around 150 per cent, but the debt-to-income ratio remains very high by historical and international standards.

So a key question when forecasting the strength of the recovery is how much difference that legacy of debt will make to people's behaviour, and their view of the right split between spending and saving.

Reflecting on the issue last month, the Treasury said that while it was hard to say how much further the debt-to-income ratio had to fall, history might provide some guidance.

Over the past 20 years the average debt-to-income ratio was about 100 per cent; over the past 10 years it was about 130 per cent.

"If households were content to let income growth do all the adjustment, it would take about 10 years to reach the 20-year average," Treasury said. If the object was just to get back to the average of the past 10 years, then the adjustment over the past couple of years has moved households about a third of the way there.

Why would they not be content to leave the debt-to-income level at its current elevated level?

The prospect of higher mortgage rates, for one thing. The average mortgage rate is the lowest it has been for at least 16 years, but it is only matter of time before the Reserve Bank starts raising rates again.

The share of households' combined income going in interest costs has fallen from a peak of 15 per cent in mid-2008 to about 11 per cent now.

If that seems low, remember that only about a third of households are owner-occupiers with a mortgage. It is still above the 20-year average of 10 per cent of income.

On the other side of the balance sheet, house prices have held on to almost all of the steep gains they recorded during the boom.

The Real Estate Institute's price index peaked in November 2007, at a level twice as high as five years earlier. It then dropped 11 per cent by the start of 2009 but has since recovered most of that fall to be just 5 per cent off its peak.

This has spared home-owners the wealth destruction which has hit their counterparts in some other countries which also enjoyed property booms, including the United States.

But it also means that house prices remain high by traditional affordability measures such as relativity to incomes and rents.

While there are recent signs the Auckland property market has turned the corner, the national picture remains grim, even when Canterbury is excluded from the numbers. Turnover in March was up just 1.5 per cent from the depressed levels of a year earlier, and the median house price up just 1.2 per cent.