Debt and the Property Market
Posted on Thu, Apr 29, 2010
It’s called “plastic anesthesia”, South Africans’ drug of choice. We go to the store, select our wants, hand over a plastic card and whoosh - we walk out with the goods, a numb smile stuck to our face. No gut-renching pain, no prick, not even a little tingle - that all comes much later. Perhaps "buy now, pain later" more accurately describes the process.
Household debt levels remain consistently high, at 79,8% of disposable income. And with no significant signs of abating, credit-quality improvement remains challenging. There are two main levels of the economy - micromacro (the economy as a whole). From the proliferation of debt-counseling services and anti-stress drugs being prescribed, it would appear that we primarily need help at the micro level.
But how does such debt affect our property market? Primarily, in two ways:
It affects the affordability of bond repayments.
Financial institutions no longer work on a simple 25-30% of income to determine whether you can afford a bond payment. Your overall indebtedness feeds into current lending policies, guided as they are by the National Credit Act (NCA) since 2007. In addition, the recent recession has made banks more cautious. Funds used to service clothing accounts, vehicle finance, credit-card debt, child-support and alimony payments are all taken into account before determining how much you can afford to pay off on a bond.
The overall affordability of property in South Africa has improved over the past 2 years on the back of house price deflation in 2009 and continuing wage inflation but is unlikely to improve further. With relatively high stock levels, the ratio between household income and house prices is expected to remain static before notable increases in house price inflation may appear during 2011-2013. Thus, current high debt levels contribute to the constraint of real-estate sales.
And secondly, it affects credit ratings when applying for a mortgage bond.
Flaws in your financial management skills flash like red-lights to accountants assessing credit-worthiness. We take on extra debt in good economic times with little regard for the cyclical nature of the beast. In addition we have seen household savings decline into negative territory. The risk associated with this increase in household debt, and the concomitant decrease in savings, is that households are not able to service their debt when the economic climate deteriorates or their circumstances change. The debit-service ratio is an important indicator in this risk assessment.
The SA Reserve Bank focuses their debt-service calculation on the interest repayment component of debt rather than the capital repayment component in recognition of the flexibility of modern credit-extension practices. Since most of the bonds provided by banks were extended within the past 5 years, the bulk of repayments consist of interest with only a tiny portion attributed to capital. This makes bankers anxious. Should you default there is a real possibility that the price achieved from repossessing your house will not cover the capital amount still outstanding.
So they look at the number of accounts you have opened recently, whether the debt is high risk (micro-loans), the number of late payments, the length of time at your current employer, type of employment and industry you are involved in. These and other factors will evaluate the risk you pose to them, whether they will extend credit and at what rate (relative to prime rate).
Can you, as a consumer, be pro-active? Yes, indeed. Regularly check your own credit record. Both ITC and Experian offer one free credit-report each year per person, as mandated by the NCA.
If you are a real-estate professional, obtain permission from potential buyers and tenants to perform credit reports and ensure you are working with credit-worthy clients. SAPTG now offers a quick and easy credit-check report for precisely this purpose, to members and non-members alike.
Knowing your status is the first step to successful personal financial management, to awakening from “plastic anesthesia” and feeling the cold reality of credit risk. With that in place, buying property becomes a lot simpler.