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?
Well … maybe.
Lower interest rates mean borrowers can service a bigger loan. Which can push prices up in a competitive housing market (something we have definitely witnessed this past decade).
So what’s really going on? Are low-interest rates been good or bad for homebuyers?
Crunching the numbers
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 $491,000. After paying a 20% deposit a buyer would have been facing a mortgage of about $392,800 with repayments of $2,977 per month over 25 years.
By mid-2020 average mortgage rates were around 4.52% 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 eight years the average price of houses increased by 40.6%, so after paying a 20% deposit the mortgage needed to buy the average ‘residential dwelling’ jumped to $552,000. Ouch!
But here’s a soother. At an interest rate of 4.52% the repayments on this much bigger loan work out at $3,075 per month – an increase of around $98. That may seem a lot but when you take into account that from 2011 to 2020 average weekly ordinary time earnings increased by 24.7%, this extra $1,422 per month in income has this higher repayment easily covered.
The upshot? On the base numbers, the average house is about as affordable in the current low-interest rate climate as it was in high-interest-rate 2011; and more affordable when wage increases are taken into account. One thing this analysis doesn’t capture, however, is the deposit. When 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 also 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 homeownership in those markets.
So what is ‘affordable’?
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 45% of their 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 much more comfortable 22.5%. But how much more comfortable? Well, it would be comfortable so long as the mortgage interest rate didn’t suddenly jump to 8.4% pa as this is when they would reach the threshold of mortgage stress. It must be noted, however, that such a large and immediate jump is unlikely.
Dealing with the big numbers associated with buying a home can be daunting. If you need help in working out a plan towards homeownership, or in managing a current mortgage and other household debt, talk to your financial advisor.
If you like this article, you might be interested to know that we share useful thoughts and information like this in our monthly financial insights email. You can subscribe to that email here. All subscribers receive a copy of our e-book: The 5 Key Pillars of Financial Independence.
General Advice Disclaimer
This article contains general advice only, which has been prepared without taking into account the objectives, financial situation or needs of any person. You should, therefore, consider the appropriateness of the information in light of your own objectives, financial situation or needs and read all relevant Product Disclosure Statements before acting on the information. Whilst every care has been taken to ensure the accuracy of the material, Paradigm Strategic Planning or Sentry Advice Pty Ltd will not bear responsibility or liability for any action taken by any person, persons or organisation on the purported basis of information contained herein. Without limiting the generality of the foregoing, no person, persons or organisation should invest monies or take action on reliance of the material contained herein but instead should satisfy themselves independently of the appropriateness of such action.
Paradigm Strategic Planning Pty Ltd is an Authorised Representative of Sentry Advice Pty Ltd AFSL 227748