Dealing with the 'housing wealth effect' – to your advantage

Are you feeling wealthier, less wealthy or somewhere in between? You may be experiencing what is sometimes called “the housing wealth effect”.

Movements in house prices, up and down, can affect how we feel about the state of our wealth and our willingness to spend, suggests a Reserve Bank paper* published several years ago.

Under this theory, if house prices are up, we may tend to feel wealthier and willing to spend more on consumer goods including new cars. And when house prices are weakening, we may tend to feel less wealthy and less willing to spend as freely.

As housing prices have continued to weaken in most Australian states, led by Sydney and Melbourne, you may decide to reduce your consumer spending due to the housing wealth effect. And you may be more inclined to save more in such ways as accelerating your mortgage repayments.

While overall new car sales have eased over the year to August, sales of luxury cars are at their lowest for more than two years, according to an update of the CommSec Luxury Vehicle Index. This index is based on the Australian sales of 17 upmarket models.

Historically-low interest had been, of course, a major driver of the last rapid rise in housing prices. (The Reserve Bank this month held the official cash rate at the record low of 1.5 per cent – a level held for almost two years.)

Yet continuing low rates provide an opportunity for many homebuyers, depending upon their circumstances, to build a mortgage buffer or cushion using mortgage offset accounts and redraw facilities.

By putting aside more than the required mortgage payment, homebuyers create protection to help deal with financial setbacks, such as illness or job loss, and future rate rises.

When interest rates fell over the past decade, many homebuyers chose to keep their monthly repayments at the same dollar amount while many developed a habit of making higher repayments whenever possible.

The Reserve Bank reports that homebuyers early this year held a total in mortgage offset accounts and redraw facilities equal to two and a half years of scheduled repayments.

Particularly given Australia’s record household debt, it makes much sense for homebuyers to try to use the “housing wealth effect” to their advantage by building a bigger mortgage buffer – a task made more achievable by low interest rates.

In a speech this month, the Reserve Bank continued to highlight the rise in household debt – up from 70 per cent of household income in the early 1990s to 190 per cent today. Australia’s total household debt-to-income ratio has been rising in recent years more sharply than in other advanced economies.

The rise in household debt is “largely due” to a rise in mortgage debt, the Reserve Bank notes. Low interest rates have enabled homebuyers to borrow more – a key influence in a country of enthusiastic homeowners.

* Housing wealth effects: Evidence from new vehicle registrations, Reserve Bank Bulletin, September 2015.

Written by Robin Bowerman, Head of Corporate Affairs at Vanguard.

Please contact us on 03 9038 9449 if you seek further assistance on this topic.

Source : Vanguard September 2018

Reproduced with permission of Vanguard Investments Australia Ltd

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