Tuesday’s interest rate rise means homeowners are now going to have to deal with something they have not had to deal with for more than 11 years. Not only that, but there is also the prospect of mortgage repayments never again being as low as they are now. It means housing affordability is going to become much worse.
After a record 137 months without a rate rise, to be honest, in the end I thought the RBA’s reasons for raising the rate were rather feeble, given wages growth remains well below inflation. Philip Lowe’s statement read more like one searching for justifications rather than an explanation.
The governor told reporters on Tuesday that “business liaison and various business surveys has indicated that there is now stronger upward pressure on labour costs”. Although he also noted that while “some firms are paying higher wages to attract and retain staff … there is still considerable inertia in the wages system”.
Let us hope the data reflects the liaisons and surveys with businesses and not the inertia.
As it is, last week’s inflation figures forced the RBA’s hand, not so much because raising the cash rate would stifle inflation, but because it meant the real cash rate (ie taking into account inflation) was absurdly low:
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The cash rate remains 3.4 percentage points below underlying inflation, and thus monetary policy remains very expansionary.
So it is not surprising that Lowe suggests more rises are on the way – possibly up to 2.5% by the end of next year.
Such an increase remains well below the absurd predictions in the futures markets, which would have the cash rate above 3.9% by August next year – a speed of increase that would assuredly cause a recession:
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But while the increases might not be that fast, they are coming, and that means housing affordability is about to be crunched.
We know house prices are absurd – in New South Wales, the average home loan is more than seven times that of average male full-time earnings:
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But interest rates since November 2010 provided something of a buffer to falling affordability from rising house prices. Yes, saving for a deposit became a massive hurdle, but the mortgage repayments, at least, were not as bad as they might have been because rates kept being cut.
But that is over now.
It means the affordability of not only buying a house, but repaying the loan will be as bad as it has ever been.
The balance of interest rates, loan sizes and earnings is why arguments that those under 40 don’t know how good they have it because they don’t have to pay 17% interest rates are rather silly.
Back in 1990, when the standard variable rate hit 17%, the average new loan in NSW was about $100,000 and the average annual earnings for a full-time male were about $32,300.
That meant mortgage repayments accounted for nearly 53% of such an annual income.
Currently the repayments on a new average loan in NSW are about 45% of annual average male full-time earnings:
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That might sound like those in the 1990s had it tougher, but they didn’t.
Because here’s the thing: if you had taken a loan out in January 1990 you did not pay 52% of your average weekly earnings on repayments for long – because interest rates fell.
Similarly, someone born in 1952, who in 1982 at the age of 30 took out an average-sized home loan in NSW of $40,200, made repayments worth only 28% of male full-time average earnings.
And yes, in 1990 they too had to pay 17% rates – but while that increased the monthly repayments by 21% from $443 to $557 a month, in that same time, average annual male full-time earnings rose 73% from $18,662 to $32,318.
By contrast someone born in 1980 who took out a loan in 2010 was looking at spending 43% of male average full-time earnings repaying their $400,000 loan.
And even when interest rates fell to record lows they were still making repayments equivalent to about 23.4% of those earnings:
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To put it another way: even with record low interest rates, a millennial would on average be paying more of their income on mortgage repayments than a baby boomer was when interest rates were at record highs.
By the time someone taking out a 30 year loan in 1982 made their last repayment, it was equivalent to just 4.2% of a month of male-full-time earnings.
Sure, they had to pay 17%, but they spent a lot more time paying a lot less on a much smaller loan, and their income rose faster than it does now.
Consider that the total repayments over the first 10 years of a loan taken out in 1982 were worth 21% of male full-time earnings over that decade, compared to 27% for someone who took out a loan in 1990.
But for someone who took out a loan in 2010, the average total repayments were equivalent to 34% of the total a male on average full-time earnings made from 2010-2019:
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But here’s the real worry. Someone who took out a loan in 2020 has already spent on average the equivalent of 35% of male-full-time earnings repaying the mortgage.
And that is likely as good as it is going to get.
Let’s say interest rates go up 2.5% points as suggested by the governor of the RBA. That means by the end of next year the monthly repayments on a $610,000 average 2020 loan at the standard variable rate will rise by 31% from $3,098 to $4,067 in 18 months.
Does anyone think wages will rise by that amount?
Forget trying to say people are lucky now not to be paying 17% interest rates. Any way you slice it, housing affordability is much worse now, and about to get more so.
