A Debt Overhang happens in a household when the household spending is significantly greater than the household income. It is up to the point that the household can’t already take on additional debt to finance other expenses. Household debts consist of the debts of all members of a household. It includes consumer debt, mortgage loans, home equity loans, auto loans, student loans, and credit cards.
Debt overhang is certainly a liability. The effect of this is that you can’t buy even the most important things. It serves to prevent current investment since all of your income would all go to your existing household debt leaving you only with just a small incentive that will make it so hard for you to recover from your difficult situation.
According to the RBA (Reserve Bank of Australia), the negative effect of debt household spending is common in households.
Having a household loan that is bigger than the principal amount than the free market value can greatly affect the purchasing and saving decisions of the household. Debt overhang requires the household to lower their leverage, for that reason, it will discourage spending for household, and this can be a barrier to the growth of the economy.
It can also affect new investments, as banks or other financial institutions may refuse to approve your new loan if you still have an outstanding mortgage or loan.
Just recently, RBA has released news that explains higher debts influence the decline of household spending. It explains how the increase in owner-occupier debt has a significant effect on spending across all sectors of the economy. In this regard, homeowners are challenged to reduce their spending when their mortgage loans are higher than their income.
Having a household debt overhang problem will lead to a demand for higher wages to work. In return, companies might be increasing their salaries but only with few vacancies.
The Government can either substantially lower the cost of debt service in the means of lowering interest rates and deposit ratios to make credit more easily available. It can also be through reformation in the financial sector, and the extension of maturity short term debt. They can also create frameworks to reduce the book value of debt in relation to excess production through market consolidation or debt reprofiling.
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