Why your mortgage may be a time bomb

Why your mortgage may be a time bomb
By Robin Bowerman | March 14, 2003

Write this down – mortgage rates at 10.5 per cent – put it in a sealed envelope and mark it Open in 2006.

You will know it is time to open the envelope, according to one of Australia’s leading economic forecasters, because when mortgage rates get that high there will be “blood on the streets”.

BIS Shrapnel, an economics forecaster that is a specialist in the property market, this week released its updated predictions and in terms of the economic outlook and business investment it was largely good news. While BIS Shrapnel’s Dr Frank Gelber agrees that growth will slow down this year he argues people are far too pessimistic about the longer-term outlook and believes a strong growth cycle is waiting in the wings, ready to fire next year and the year after once the impacts of drought and the uncertainty about the Iraq conflict work through the system.

Gelber and the BIS Shrapnel team have an impressive track record of getting closer than just about anyone in recent years with their medium-term forecasts. Certainly when the Asian crisis hit he was a lone voice in the wilderness predicting a strong rebound in growth when others were predicting the end of civilisation, as we know it.

In some ways his message is similar this time around. Clearly the international situation with Iraq is unsettling and our economy will slow down through the year. But Gelber argues the stage is set for a “strong and sustained upturn in investment” which will fuel growth through to 2006 and 2007.

Low interest rates continue to be a key driver but Gelber argues that as the growth cycle gets underway the Reserve Bank will have no choice but to lift rates aggressively to stop inflation getting out of control.

The bad news for people with mortgages is that several years of low interest rates have made it easier to borrow more but that naturally increases the pain if rates move up significantly.

Household debt is now running at 125 per cent of annual income so clearly a quick spike in interest rates will put people under pressure to service their debts.

Some economists are arguing that if people are more heavily geared when rates rise the impact should be felt faster so rates may not need to go as high as in previous rate cycles.
Unfortunately, while individuals will feel the pain faster, most of the growth is going be driven by business investment which is slower to react and that, according to BIS Shrapnel senior economist, Matthew Hassan, is why rates will get well above 8 per cent and heading to 10.5 per cent sometime in 2006-2007.

The good news for property investors, according to Hassan, is that residential property in the major cities, with the exception of inner-city apartments, is not at risk of a major price slump. BIS Shrapnel is predicting a mild price decline around 4 per cent in the next 12 months or so before prices begin to rise again as the economy starts growing strongly, household incomes rise and business investment kicks in.

Hassan says it will be a classic property cycle – and a big one – and the Reserve Bank will be in for a testing time.

For individual investors the messages are mixed: strong growth is good for jobs and higher wages. But as the cycle turns later this decade people with high borrowings will find themselves under extreme pressure if they cannot service the debt.

The Bis Shrapnel forecasts is an early warning and gives people time to get debt to manageable levels but if you leave it to 2006 to open that envelope it may be your blood on the street