It goes without saying that homebuyers love low interest rates. The lower the interest rate the less the mortgage repayments on a particular house, right?
Lower interest rates also mean borrowers can service a bigger loan. In a competitive housing market that can push up prices, as we have witnessed this past decade.
So what’s really going on? Have low interest rates been good or bad for homebuyers?
The numbers crunched
In mid-2011 the average interest rate on a standard variable home loan was 7.79% p.a. and the average price of homes across Australia’s eight capital cities was around $478,000. After paying a 20% deposit a buyer would have been facing a mortgage of about $382,400 with repayments of $2,899 per month over 25 years.
By mid-2018 average mortgage rates were around 5.20% p.a. That’s great for anyone who took out a mortgage at higher rates and has refinanced, but what about new entrants into the housing market? In the intervening seven years the average price of houses increased by 43.8%, so after paying a 20% deposit the mortgage needed to buy the average ‘residential dwelling’ had jumped to $551,000. Ouch!
But here’s a soother. At an interest rate of 5.20% the repayments on this much bigger loan work out at $3,286 per month – an increase of around $380. That may seem a lot but when you take into account that from 2011 to 2018 average weekly ordinary time earnings increased by 21.5%, this extra $1,215 per month in income has this higher repayment easily covered.
The upshot? On the base numbers, the average house is about as affordable in low-interest-rate 2018 as it was in high-interest-rate 2011; and more affordable when wage increases are taken into account. However, one thing this analysis doesn’t capture is the deposit. If house prices increase at a greater rate than average earnings, new homebuyers have a harder time saving the deposit they need just to get to the starting line.
The problem of averages
Average numbers hide a wealth of detail. House prices in Melbourne and Sydney have followed very different pathways to those in Hobart and Darwin. Over the past few years some cities have become more affordable as a result of lower interest rates and stable house prices. Sydney and Melbourne house prices have blown out of proportion, making it much more difficult to get a foot on the ladder of home ownership in those markets.
The generally accepted rule of thumb is that a household should not spend more than 30% of pre-tax income on mortgage repayments. Any more is defined as ‘mortgage stress’.
In the example above, in 2018 someone on the average wage would be spending 48% of his or her gross income on mortgage repayments. In other words, a single average wage earner can’t afford an average house.
Fortunately, for couples with both earning the average wage, the figure is a more comfortable 24%. But how much more comfortable? In the worst case, if their mortgage interest rate jumped to 7.6% p.a. immediately after taking out their mortgage they would reach the threshold of mortgage stress. Such a large and immediate jump is unlikely, but as we’ve seen recently higher interest rates are on their way.
Dealing with the big numbers associated with buying a home can be daunting. If you need help in working out a plan towards home ownership, or in managing a current mortgage and other household debt, talk to one of our financial advisers.