PHOTO: Australia has gone house buying mad and if house prices drop it could have a huge effect on our economy.
New research shows what will happen if house prices fall. The news is bad. It turns out Australia is so puffed up on housing wealth that if house prices fall they drag down a huge section of our economy with them.
The Reserve Bank of Australia put out new research on Tuesday with some dire warnings. RBA investigated the effect of a 40 per cent fall in house prices – a fall they described as “extreme but plausible”. That would mean a $500,000 home falls to $300,000 and a $1 million home falls to $600,000.
They chose that figure because such a fall has happened in other countries during the global financial crisis (GFC). They also assume rising unemployment falls and a sharemarket crash.
They then ran a few scenarios to see what will happen. The bank was mostly trying to investigate Australia’s record high household debt. As we know, Australians have borrowed up to their eyeballs. We have some very big mortgages. But what they found is a different weakness.
MORTGAGE DEFAULTS
A lot of people worry about mortgage defaults. Here’s how that works in theory: If house prices crash, people end up owing more on their loan than the loan is worth. If they default on the loan, the house then belongs to the bank.
That can be a problem for the bank – it gets a house that’s not worth much and there’s nobody to pay off the loan. If a lot of people do this banks can lose so much money they go broke and the Government needs to save them.
However, in Australia this isn’t going to happen, according to the RBA. Our banks, the lucky buggers, will be fine. Even if house prices fall by 40 per cent, they can handle it. About 2 to 3 per cent of people will default on their loans but that’s not enough to send the banks broke.
A lot of banks in other countries went broke during the global financial crisis and we learned from that. We built up the strength of our banks. They have something tucked away for a rainy day. They also make some riskier borrowers get insurance – called Lenders Mortgage Insurance – that will pay out if they stop paying their loan.
So – if the RBA calculations are right – we don’t need to worry about our banks collapsing. What we need to worry about is something else.
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