Millennial Money: Mortgages Part 2
Updated: Aug 19, 2022
Welcome back to another Millennial Money article where we demystify key concepts in personal finance affecting university students. We continue our discussion of Mortgages, this time focusing more on the implications of the RBA’s announcement (to raise the cash rate) on owning your own home. Much of the press has been negative on this announcement, but we want to give an alternative perspective. The Great Australian Dream The Great Australian Dream is a phrase which is used to describe the aspirations of Australians to own a home. The historical origins of this phrase are quite interesting (began in the post-war era) and allude to a time when this dream was within reach for a greater percentage of the population. Unfortunately, this is becoming more difficult to achieve. The most common metric to measure this is the years taken if saving 20% of income (the most common deposit amount). For example, in October 2021, this took the average Melbournian 7 years and 4 months, second only to Sydney. This has increased by over a year since 2017. Record low interest rates which have made borrowing cheaper and saving more difficult and seen soaring house prices, have played a role in this outcome. Housing Crisis 2.0: Fact or Fiction This leads into last week’s announcement: the RBA announcing an increase in interest rates. The key point that we want to highlight is the RBA’s intention to restore the cash rate to 2.5%, in line with the midpoint of its long-run inflation target. What this means in turn is that interest rates on savings accounts will increase, borrowing rates will increase and house prices will decrease, as higher discount rates are factored into valuation. This is leading some to suggest that another housing crisis may be on the cards. While there are some nuances, the main argument is that people who have bought houses at record prices during the pandemic are relying upon low interest rates to make repayments. Furthermore, in the event they are unable to make interest payments, they are relying on rising housing prices so they can sell their house for a profit. It then follows that the higher interest rates discussed above lead to higher repayments and potentially negative equity (the house becomes less than what it was paid for). If this impacts too many borrowers and homeowners, then this creates an unwanted spiral of decreasing house prices and potentially a severe economic downturn, much like the GFC. But fear not. There are certainly some signs that this may be over exaggerated. For example, RBA governor Phillip Lowe quoted analysis of household savings which found that the average household had gained a year on their mortgages (that is they were a year more ahead of their repayments) between 2018 and 2022. This implies that they would be able to absorb increases in interest rates. Also, it is worth noting that the real interest rate, at least for most borrowers, is still very much in negative territory, so, on the assumption that wages growth begins to catch up with inflation (and there is some evidence this is beginning to occur), repayments should still be easier for the average household. Finally, this may make housing more affordable for first homebuyers because they earn a higher interest rate on savings accounts and don’t need to save up as much if house prices fall. Indeed, we saw that during a period of low interest rates it has become increasingly difficult for prospective homebuyers (that’s us) to buy their first home. Therefore, restoring interest rates to normal levels may be exactly what we need to realise the Great Australian Dream. More Information If you are interested in more information about housing have a look at these websites/articles:
Conclusion That wraps up our discussion on housing (for now) and also our Millennial Money series for this semester. We hope you found these articles helpful and enjoyable (we certainly enjoyed writing them!) and that you are now more interested in doing further research about personal finance.
The Finance Student's Association is not a financial adviser, the views expressed within this article are those of the authors and do not represent the views of the Finance Student's Association. All images and references in this article are for fair and educational purposes only. The content in this article is not intended as legal, financial or investment advice and should not be construed or relied on as such.