A recent report from AMP highlights some concerning statistics regarding the growth in household debt in Australia since 1988.

Blog: should you be getting into more debt?

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Continuing low interest rates, a relatively strong economy and generally low unemployment levels have encouraged Australians to borrow more.  But, it is the extent of “more” that is somewhat concerning - $60,000 in 1988 to $245,000 now after allowing for inflation.

Of course, when we are looking at debt, the amount of debt is only part of the equation.  We also need to look at ability to repay and here the picture is not pretty either.  Debt has grown at 5.3% above inflation while income has grown at 1.3%.  This means that the average household would have needed 8 months of its after-tax income to repay all debt in 1988 but now needs two years to achieve that objective.

Interestingly, 93% of the debt is for home loans (56%) or investments (37%) while only 2% is owed on credit cards but it is often the credit cards with their exorbitant rates of interest that attract the attention of commentators.  This is probably because credit card debt is typically incurred for consumption expenditure and so is almost exclusively “bad debt” (debt with no tangible asset backing and/or no taxation advantage).

The common practice of drawing on the home loan to fund a holiday or car purchase (other examples of “bad debts”) would also be represented in the 56%.

Is this a problem? May I suggest 3 scenarios?

  1. Interest rates rise. I know it’s been a long time since they have risen but they will not stay at record lows forever.  When they do increase, the pain of repayments will also increase.
  2. Loss of employment. Although employment rates are steady, the disruption that is occurring with changes in many industries may cause unwelcome career changes.  Will your new career pay as well as your current employment?
  3. Loss of earning capacity. An accident or illness may prevent you from earning an income causing debt to become a major problem particularly if selling assets is not a viable option.

Any of these scenarios can and do occur to ordinary Australians.  Would any of these be a problem for you? 

Just remember, debt can be a useful tool for those who want to build wealth.  However, it is important that the use of debt is managed properly and sufficient buffers are built into the plan to ensure the risks associated with high debt levels don’t derail the overall plan.

Seeking professional advice (preferably before signing up for major debt) will help you be aware of and plan for adverse changes in your financial position.  Debt has the potential to turn from a useful tool to “cement boots” (financially).