Our debt binge will trigger a nasty hangover

I really, really, really hope I’m wrong, but I fear this will end badly for many, many, many people.

Too many people have borrowed too much money to buy homes that were priced too high. They’ve placed themselves in this precarious position because of three false assumptions:

• The economy will always be steady
• Property prices will always rise
• Interest rates will always be ultra-low

If history teaches us anything, it’s that another recession is inevitable. We don’t know if it will occur next month or next year or next decade, but we know it will happen sooner or later.

When that happens, people will lose their jobs. In some cases, they’ll have to sell their homes to raise cash; in other cases, the bank will sell their homes for them because they’ve fallen behind on their mortgage repayments. That means a lot of extra stock will hit the market.

While that’s occurring, the economic downturn will trigger a decline in consumer confidence, which in turn will reduce the number of buyers in the market.

So supply will go up and demand will go down. The result? Falling property prices.

Sadly, some people will find they now owe more money than their homes are worth.

Interest rates would probably fall during a recession, so it’s unlikely borrowers would be hit with a triple whammy of negative economic growth, falling property prices and higher repayments. However, banks might raise interest rates while the economy remains healthy; indeed, we’ve started to see that, as banks try to boost their profit margins. An increase of 1 percentage point could be devastating for borrowers at the limit of their financial capacity – even if they don’t lose their job. That could then trigger the aforementioned scenario of properties being offloaded during a falling market.

Some critics will argue my fears are overblown. I hope they’re right. But consider these four pieces of evidence:

1) In a speech earlier this month, Reserve Bank governor Philip Lowe said that while the national housing market had its good points, there were “clearly risks” associated with Australia’s “relatively high” level of household debt.

2) An IMF report from February noted that while Australia’s economy was reasonably sound, there were “housing-related vulnerabilities” and “risks related to house price and debt levels”.

3) Household debt grew 10.8% between September 2014 and September 2016, according to the most recent data from the Australian Bureau of Statistics. That’s significantly faster than the growth recorded by the economy (4.3%) and population (2.7%).

4) Financial Counselling Australia chief executive Fiona Guthrie recently told the ABC that about 30% of households are in some sort of financial stress. She also said the organisation’s National Debt Helpline had received a record number of calls in January.

There’s another point worth mentioning: if you think the banks are mean now, they’ll only get more unforgiving during a recession. That’s because they’re going to take a financial hit from all the bad loans they’ll have to write off. So any struggling borrower who asks for help is likely to get short shrift.

My hope is that anyone who’s currently in a financially precarious position will start getting their house in order. Otherwise, when things turn bad, they might lose it.

[Bonus read: Why a corrupt politician can teach us a lot about business]