Browsing the headlines this morning, I spotted an article from an Australian source talking about how one million property owners are about to default on their mortgage payments. Admittedly, I\’m not 100% certain how many people are in the Australian mortgage market, but one million defaults sounds like a significant volume to me.
The key driver behind this impending wave of defaults is the fear that four of Australia\’s largest banks are about to increase the rates on their standard variable rate mortgages by 0.15% in the coming months. According to the article, several Australian banks have already started to raise their interest rates.
Outside of Australia, the US Federal Reserve is considering increasing rates, and I read an article the other day from Mark Carney, the Governor of the UK\’s Bank of England, who is sounding increasingly positive about raising rates (although in fairness he\’s been talking about it for years and not touched them…).
The source in the Australian article, Martin North, works for a market intelligence firm called Digital Finance Analytics, which surveys market participants to make forecasts. According to recently surveys, hundreds of thousands of households across Australia are under what he calls \’mortgage stress\’, where they have little to no ability to handle increases in their mortgage rates due to stretched budgets and overleveraged positions.
Over here in the UK, I\’m seeing flashing red lights across the property industry, with many major construction firms issuing profit warnings (if not outright losses), most of the major estate agencies issuing losses and declining financial revenues, and hundreds of small estate agents facing failure. Add in the huge volume of people talking about what a great deal property is and it seems like we\’re heading straight for the next economic cliff-face.
In fairness, people have been predicting the next recession since about 2013. I know one commentator that talked about it in every blog post he put out for years (well, nearly every blog post). He finally stopped this year…but if anything, I think he was wrong to. With so much cheap debt swilling around the system and interest rates so low, I really struggle to see how we won\’t have a major collapse in asset prices across the board when interest rates return to normal levels.
For anyone that\’s purchased assets in cash, has a significant cash reserve or a strong net positive cash flow, the rise in rates shouldn\’t cause too much of an immediate problem. But for anyone that\’s borrowed and leveraged themselves to the hilt while rates were low…that money will have to be repaid. Ask yourself – if your monthly repayments doubled tomorrow as a result of the interest rate rising from 0.25% to 0.5%, would you be able to repay twice as much as you did last month? What about if they doubled again after that, and again after that?
Historically, the base rate has been set at about 4% which means that your repayments could increase by 20x…just ponder that one for a moment. If you couldn\’t afford an increase in repayments of that level, how do you think your neighbours are going to manage it. So what will happen? They\’ll stop paying, the lenders will reclaim the assets and then what? Do you think they\’ll just sit on them – of course not, they\’ll need the cash to reflate their balance sheets. Hundreds of houses, cars, jewelry, TVs, all being sold off at once. Why buy at the ticket price when you could go next door and get it for 20% off…or 40% off…why not 60% off?
As a species, we\’ve got pretty short-term memories. Property will \’always\’ go up. Shares are a \’sure thing\’. \’This tie it will be different!\’. I\’ve heard it all before – I think we all have. And yet economically we follow the same patterns time and time again – we pump debt into the system, overpay ourselves things we can\’t afford, then interest rates go up to slow down inflation, the system collapses, millions lose their jobs and homes, we say \’never again\’ and then repeat it all over the next ten years or so. If you\’re in the markets at the moment – property or shares – my advice would be to be very careful what you\’re investing in and at what price, because unless you\’ve got cash to burn, you could be buying a price you won\’t see again for many, many years to come…