It is impossible to predict outcomes a year or two in advance, so to take a twenty year view all comes down to managing risk and having sufficient security. The banks are experts in this and when economic growth is slow and consumer finances are under pressure, lending criteria become significantly tougher and effective interest rates at which mortgage loans are provided, are increased. Our prime interest rate is currently 8,5%. Whereas pre-2007 most rates quoted by banks were prime less a certain percentage, nowadays most rates quoted are prime plus a certain percentage based on their risk profile they attach to you. As an example FNB take the data provided by the South African Reserve Bank in their quarterly reviews and calculate the Household Sector Debt Service Index which is an excellent measure of the country's household sector vulnerability and its ability to service its debt in the future. From a revised 1st quarter 2013 index level of 6.54 (on a scale of 1 to 10), the 2nd quarter saw a slight rise to 6.59. The higher it goes the more vulnerable households are. Relative to its long term (33 year) average of 5.2, the index remains high. The index is compiled from three key variables, namely, the debt-to-disposable income ratio of the household sector, the trend in the debt-to-disposable income ratio, and the level of interest rates relative to the long term average (5-year average) consumer price inflation.
When an economy is exposed to unwanted "shocks" such as interest rate hikes or downward pressure on disposable income, the ability to weather these storms depends largely on how vulnerable households are at the time. So where are these three key indicators trending towards and what should we watch out for? Firstly debt-to-disposable income remains high at over 75% and although this has declined from the peak of approx. 83% in 2008, the trend (which brings us to the second variable) has changed and the 2nd quarter of 2013 saw a resumed rise in the ratio.
Disposable income has been decreasing over the past few quarters, but debt levels remain high. If debt levels trend upwards, suddenly this ratio will increase and our vulnerability status will increase accordingly. The third key variable of interest rates to consumer inflation is high at 7 (out of 10). Interest rates are currently low, and have been for a while, but the risk now is that they have little further room to decrease and the probability is that they will increase over the next few years. FNB predict that households, given their current profile, could handle interest rates increasing to around 11,5% before severe financial pain would set in. This 3% interest rate hike would be considered mild by historical standards. The warning now therefore is be very careful before adopting more debt.