Naive borrowers pose risks

If taking on too much debt is inadvisable at the best of times, it’s downright foolish if borrowers don’t understand how their loan or compound interest works. Yet this appears to be the case for swathes of homebuyers. A new survey from investment bank UBS suggests a third of borrowers who have taken out interest-only home loans, which all up are worth about $640 billion, believe their monthly repayments erode their principal. A separate survey by ME Bank suggests more than 40 per cent of borrowers don’t even understand compound interest. In an age of compulsory superannuation and endemic 30-year mortgages, financial literacy is more important than ever.

Australia’s property market consistently has proved the doomsayers wrong since the financial crisis: it hasn’t crashed under the weight of mounting household debt. Yet there is no room for complacency, as new research from the International Monetary Fund this week shows. The median level of household debt as a share of gross domestic product has climbed in rich countries from 52 per cent in 2008 to 63 per cent last year — so much for “deleveraging”. The IMF put some statistical flesh on the commonsense point that higher debt may boost economic growth initially, but ultimately it weighs on output. A five percentage point increase in household debt to GDP across a three-year period, it found, is linked with a 1.25 percentage point decline in growth three years later. That bodes ill for Australia, where that measure of debt has increased 15 percentage points to 123 per cent since 2012 alone, according to data from the Bank for International Settlements. Referring specifically to Australia, the IMF said “homeowners increased consumption in response to higher local house prices between 2012 and 2015, and the effect was stronger for households with high financial leverage”. The concern is that process reverses if house prices ever fall. Borrowers would do well to heed warnings against excessive borrowing. Longer term, the government might consider ways to curb the artificial tax bias towards debt, as the Trump administration is proposing, for example.