Part 2 of our series on Australia’s looming debt danger.

Australian mortgage holders are under pressure now that the four big banks and a host of smaller lenders have increased their variable loan rates.

In the first part of this three-part series, we outlined why real wages were in decline, not just in Australia but across the world – and now, with the added burden of rising bank interest rates, the ability to service mortgage debt is decreasing.

Lenders have put up their rates even though the Reserve Bank of Australia (RBA) has kept official interest rates on hold at 2% for the past six months. The increases were in response to a requirement by the regulator, the Australian Prudential Regulation Authority, that they hold more in reserve in case there is another global financial crisis.

Add to this rising house prices fuelled by the availability of relatively cheap money and the red warning flags have begun flying from the rooftops.

Australian house prices relative to their long-term trend

Mortgage debt hits 91% of GDP

As expatriate economist Professor Steve Keen – who famously predicted the 2008 crash – wrote in the Irish Independent newspaper, ‘…what really causes house prices to rise rapidly is too much mortgage debt, rising too quickly.’

‘When the crisis hit in 2008, Australian mortgage debt was already higher than in the USA: mortgage debt peaked at 72% of gross domestic product (GDP) in America then, but Australia’s level was 10% higher again.

‘Today, mortgage debt in the USA has fallen to 53% of GDP – what wimps! Australians now have a mortgage debt level of 91% of GDP and rising.’

The short-term result of the increased loan rates has been a cooling of the auction clearance rates, with Sydney hitting a record low of 63.4% on the first weekend in November. The clearance rates for the same weekend in 2014 topped 80%.

Weekly clearance rate, combined capital cities

RBA acknowledges size of issue

The good news is that – even as house prices are still rising – the ‘debt-drunkard Australians’, as Keen describes us, may be rethinking how much more red ink we can tolerate.

Even though the RBA remains quite sanguine about how indebted the average household is, it still notes the size of the issue.

Household indicators

‘An increased willingness by some households to take on more debt, coupled with slow wage growth, has resulted in a further pick-up in the gross debt-to-income ratio, which has now reached new highs,’ the RBA said in its October Financial Stability Review.

However, it added, ‘…indicators suggest that household financial stress remains fairly benign, despite measures of unemployment being somewhat elevated.’ Nevertheless, ‘forward-looking indicators are more mixed’.

While Keen says Chinese buying may continue to prop up the Australian housing market, he still has a sharp word of warning: ‘As the growth rate of mortgage debt slows, the market will come down and potentially take the economy with it.’

In part 3, we will bring this together with interest rates and consider: if real household income is down, and debt levels are up (and only made affordable by low interest rates), what happens if official interest rates rise?