Australia May Face Debt Crisis From Grants to Young Home Buyers

By Jacob Greber

May 11 (Bloomberg) -- Australian Prime Minister Kevin Rudd’s bid to ensure his housing market avoids the global property slump may push a generation of buyers into a debt crisis.

Grants of as much as A$21,000 ($16,142) to first-time buyers and the lowest interest rates in 49 years have emboldened more than 40,000 young Australians to take out home loans since October, stoking demand for properties that cost less than A$500,000.

These buyers may be vulnerable when interest rates begin rising, potentially triggering a jump in foreclosures that will drive down property prices, cut profits at banks and damp household spending, which accounts for half the economy. A surge in defaults in America was a key trigger for the financial crisis that pushed the global economy into its worst recession since World War II.

“We’re mirroring what happened to the U.S. three years ago, when people who shouldn’t have been in the market bought houses,” said Martin North, managing director of Fujitsu Australia, a Sydney-based property-consulting company. “It’s a strategy set for an unfortunate outcome.”

As Australia slides into its first recession since 1991, Rudd’s payments have been criticized by economists and newspapers for fueling a property boom that may burst once the grants are reduced, possibly as soon as July 1.

No Subprime Crisis

While the central bank says Australia doesn’t have a subprime crisis because banks have tightened lending standards, recent reports show first-time buyers are driving a residential construction industry that employs 5 percent of the workforce. New home sales have surged 22 percent this year, and building approvals climbed 12 percent in February and March.

“March was the busiest month I’ve ever had,” said Peita Jackson, a real-estate agent at Bradfield & Prichard, who specializes in selling homes in Sydney’s eastern suburbs. “I sold six properties, and four were to first-time buyers.”

Former Prime Minister John Howard introduced the grants in 2000 to boost a slumping housing market. Last year Rudd tripled the payments for new homes to A$21,000 and doubled handouts for existing houses to A$14,000 to support the economy.

The increases coincided with record interest-rate cuts by Reserve Bank Governor Glenn Stevens, who has reduced the overnight cash rate target by 4.25 percentage points since September to a 49-year low of 3 percent.

Tax-Free Boost

The rate cuts have lowered payments on an average A$250,000 mortgage to A$1,470 from A$2,120. The Reserve Bank says that equals an 8 percent tax-free boost to family incomes. About 90 percent of Australians hold variable-rate loans that are adjusted when the central bank changes its benchmark rate.

“All these things have increased the demand side of property and not the supply side, which always results in increased prices,” said John Lindeman, head of research at property-information company Residex Pty in Sydney.

The 10 suburbs with the biggest prices gains in Sydney during the six months through March were all in locations where homes cost less than the city’s median price of A$564,500, according to Lindeman. The biggest jump was in Greenfield Park, 36 kilometers (22 miles) west of the city center, where the median price rose by A$23,700 to A$420,000.

“We’re setting up a whole generation of people for grief,” Lindeman said. “Interest rates will go up, and that’s when they will feel the pain.”

Prospective Owners

The government grants and interest-rate cuts have prompted first-time buyers, who accounted for a record 27 percent of dwellings financed in February, to borrow more than other prospective home owners. Lending to these consumers surged 6.1 percent between October and February to an average of A$280,600, the Statistics Bureau said. By contrast, home loans to all borrowers fell 1.1 percent to A$253,200.

“For many buyers, the grant was critical,” said Fujitsu’s North. “Over 30 percent had loan-to-valuation ratios on their properties of 95 percent or higher.”

This may eventually leave some new buyers with so-called upside-down loans, as they owe more on their mortgage than the market price of their home. That threat will be heightened if unemployment climbs above 7 percent from the current rate of 5.4 percent, as forecast by the government.

Rudd, Stevens and the International Monetary Fund have all said Australia is in a recession as companies such as BHP Billiton Ltd. and Qantas Airways Ltd. fire workers. Gross domestic product declined 0.5 percent in the quarter ended December 2008 from the previous three months.

Disappearing Jobs

While supporters of the grants say they have created 20,000 construction jobs, many of these jobs may disappear later this year. Rudd signaled last month that the increased handouts may not be extended beyond June 30, reverting to A$7,000 for new and existing homes.

“All good things must come to an end,” Rudd said April 23. The government will announce any changes to the grants when it releases its budget tomorrow.

Some prospective home buyers hope the grants will be cut.

Ludmila Soboleva, a 40-year-old drugs researcher, has been looking for an apartment in Sydney’s eastern suburbs since November, without success.

“Everyone told me this is the best time to buy something but for properties I can afford, it’s a nightmare,” she said. “I wish they would cut this grant so maybe there will be fewer people” trying to buy.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net