Interest Rates and Mortgage Payments
It seems far fetched but there was once a time when the average Australian mortgage had an interest rate of more than 17%.
Over the past 30 years, for the most part the Australian cash rate set by the Reserve Bank of Australia (RBA) resembles a long-term steady decline as the benchmark rate has fallen from 17% to the current level of 0.10%.
One of the key beneficiaries of the long-term decline in the value of holding cash has been the Australian property market.
It might come as no surprise to anyone that has been to a Sydney auction or even flicked on a TV show such as the Block to learn that Australians have a love affair with bricks and mortar.
As I have mentioned several times previously, there is an inverse relationship between asset prices (stocks, property etc) and interest rates. When interest rates fall, the value of other assets increase as the reward for holding cash declines and the relative returns needed to justify investing reduce. Alternatively, not that it has happened much recently, is that when interest rates rise the value of assets tend to fall as the risk is now competing with higher levels of safe returns.
It might come as little surprise to learn that in 1991 a home in Sydney was $182,127 and in Brisbane it was $120,879. Accounting for the inflation the corresponding prices in 2020 dollars are $260,000 and $170,000 approximately. Fast forward to the end of 2020 and these values have increased to $1,154,606 and $596,316 respectively.
When investing or owning property there are a range of factors that will go into the final price other than interest rates include; Location, nearby infrastructure, future development in the area, schooling options, employment and of course the wow factor that makes you fall in love with a home.
The decision to purchase is a major decision and should not be considered lightly with the vast majority of situations resulting in the largest debt that an individual or family will take on. One thing that must be remembered is that while the total size of a mortgage may be intimidating, in my opinion the most important factor is your ability to service the loan.
It appears that many borrowers do not consider what will happen should interest rates rise and how this is going to affect their ability to service their loan. The table below highlights the difference that this will make to the amount required to cover the mortgage.
As you can see, even small changes will make a significant difference to the minimum monthly repayments. The good news is that the RBA is likely to hold cash rates at current levels for the remainder of the year but should the economy continue to recover from Covid and unconventional monetary policy stop, there is a chance that we will be looking at rate rises in the coming years.
The RBA does have decisions to make with the 6 month bond buying purchase program to end in September and the options they have highlighted include:
ceasing purchasing bonds in September;
repeating the current $100 billion purchase program over a similar time frame;
scaling back the amount purchased or spreading the purchases out over a longer period; or
moving to an approach where the pace of the bond purchases is reviewed more frequently, based on the flow of data and the economic outlook.
The only decision that has been made is that the first option will not be taken. It is going to be very interesting to see what happens should CPI inflation is sustainably within the RBA’s target range of 2-3% per annum. Notes from RBA Governor Philip Lowe says that the RBA is still willing to raise rates in 2024 should their conditions be met.