A fall in interest rates is usually greeted with delight by homebuyers. The lower the interest rate the less the mortgage repayments on a particular house, right? Well, maybe. However, lower interest rates also mean borrowers can service a bigger loan. In a competitive housing market that can push up prices. So what’s really going on? Is a lower interest rate 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 10% deposit a buyer would have been facing a mortgage of about $430,000 with repayments of $3,259 per month over 25 years.
By mid-2016 average mortgage rates were down to 5.1% p.a. That’s great for anyone who took out a mortgage at higher rates, but what about new entrants into the housing market? In the intervening five years the average price of houses increased by 30.4%, so after paying a 10% deposit the mortgage needed to buy the average ‘residential dwelling’ had jumped to $560,644. Ouch!
But here’s the thing. At an interest rate of 5.1% the repayments on this much bigger loan work out at $3,310 per month – almost the same amount as for a 2011 buyer. And there’s something else to take into account. From 2011 to 2016 average weekly ordinary time earnings increased by 16.1%. With an extra $912 per month in income, the average wage earner has that fractionally higher mortgage repayment easily covered.
The upshot? On the base numbers, the average house was about as affordable in low-interest-rate 2016 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. In other cities house prices have continued to boom, making it much more difficult to get a foot on the ladder of home ownership.
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 2016 someone on the average wage would have been spending 50% of his or her gross income on mortgage repayments. In other words, a single average wage earner couldn’t afford an average house.
Fortunately, for couples with both earning the average wage, the figure is a more comfortable 25%. But how much more comfortable? In the worst case, if their mortgage interest rate jumped to 6.94% 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 higher interest rates in the future are definitely on the cards.
Dealing with the big numbers associated with buying a home can be a bit daunting. If you need help in working out a plan towards home ownership, or in refinancing a current mortgage and other household debt, talk to your broker.