Rate rises real risk for mortgage holders

by Miklos Bolza30 Mar 2017
It is the prospect of interest rate rises that pose the greatest danger to first home buyers, according to one finance expert who believes that current levels of housing affordability are actually not that severe.

House prices today are relatively affordable compared to the 1990s, Jamie Alcock, associate professor in the University of Sydney Business School, wrote in an article on The Conversation.

While proponents of the housing affordability crisis point to how the price of a median house is now 12.2 times the median salary in Sydney and 9.5 times in Melbourne, this does not take into account the different interest rates over history, he said.

“A house in 2017 that costs nine times the median salary, when mortgage interest rates are less than 4%, is arguably more affordable than a house in 1990 that costs six times the median salary. Interest rates in 1990 were 17%.”

Breaking this down numerically, Alcock said that a first home buyer in 1990 purchasing an average house in Sydney at $194,000 would have monthly mortgage payments of $2,765 for a 30-year mortgage with a 17% rate. The represented 111% of the average fulltime pre-tax earnings at the time.

In comparison, a first home buyer in 2017 buying a Sydney house for $1,000,000 with a 4% interest rate would only pay $4,774 each month or 69% of the pre-tax average fulltime salary.

However, he warned that first home buyers presently stand a greater risk of interest rate rises which could result in higher proportional mortgage repayments.

“This has the potential to financially destroy first home buyers and, due to the high reliance of the retail banking industry on residential real estate markets, potentially create a systemic financial crisis,” he said.

When asked whether the bank’s typical interest rate buffer was enough to avoid this risk, Alcock was less than confident.

“These are designed to protect the bank and the integrity of the financial system by ensuring that banks don't loan money to people who clearly cannot afford it,” he told Australian Broker.

“However, this buffer does not protect the variable-rate lender from suffering the consequences of any interest rate rises. The interest rate rises will flow through to the lender, requiring higher repayments and therefore less disposable income for them.”

He urged the government to broaden its focus from merely looking at housing affordability and instead tackle ways to reduce interest rate risks for mortgage holders.

Suggestions include facilitating greater competition between the banks and “encouraging (through legislative and regulatory support) greater liquidity in the domestic longer-term fixed-rate mortgage securitisation market,” he said.

“Owner occupiers could also be taxed in a similar manner to investors (incorporating a land tax combined with tax-deductibility of mortgage interest for owner-occupiers), so that some of the interest-rate risk is transferred to the government.”

Finally, the risk can also be reduced by shortening the term of the mortgage with governments and regulators encouraging banks to issue shorter-term loans.

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