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Research Note no. 8 2006–07
Home loan affordability—measurement and trends
Tony Kryger
Statistics and Mapping Section
9 November 2006
The most widely reported measures
of home loan affordability in Australia
are the Real Estate Institute of Australia (REIA) Home Loan Affordability
Indicator, the Commonwealth Bank of Australia–Housing Industry Association
(CBA–HIA) Housing Affordability Index, and the BIS Shrapnel Home Loan
Affordability Index. Each of these indexes measures affordability with
respect to new loans only. (1)
This Research Note examines each
of the above affordability measures and their limitations. The Note
also looks at the trend in home loan affordability over the past 20
years and shows how the sensitivity of home loan affordability to interest
rate changes has increased gradually over time. The Note, however,
does not examine the contribution of individual factors to changes in
home loan affordability.
Existing home loan affordability measures
The REIA Home Loan Affordability
Indicator is a ratio of median family income to average new loan repayments.(2)
The REIA indicator divided by 10 shows the number of times that median
family income exceeds average home loan repayments in a period. An increase
in the REIA indicator represents improved affordability.
The CBA–HIA Housing Affordability
Index measures accessibility to home ownership for an average first-home
buyer. It is calculated as the ratio of average disposable income(3)
per household to the ‘qualifying’ income(4) required to meet
repayments on a 25-year loan, for 80 per cent of the median price of
an average established dwelling purchased by a first-home buyer.(5)
The CBA–HIA index divided by 100 shows the number of times that average
household disposable income exceeds the minimum income needed to meet
repayments on an average established dwelling. As with the REIA indicator,
an increase in the CBA–HIA index represents improved affordability.
The BIS Shrapnel Home Loan Affordability
Index shows the proportion of full-time male average earnings needed
to meet the mortgage repayments on a ‘typical’ housing loan. A typical
housing loan is assumed to be a 25-year loan for 75 per cent of the
median house price. A decrease in the BIS Shrapnel indicator represents
improved affordability.
The REIA indicator is available
for each state and all Australia;
the CBA–HIA index is available by capital city and ‘rest of state’,
as well as for all Australia;
the BIS Shrapnel index is only available by capital city.
While providing a useful measure
of the underlying trend in home loan affordability, the Productivity
Commission has identified a number of limitations with the indicators.
In particular, each is influenced by changes over time in median house
prices that are not due to pure price movement.(6) In other
words, the indexes do not adjust for changes in affordability that are
the result of price changes caused by improvements in the quality of
the national housing stock or changes in the composition of sales (size,
quality and geographic location of houses traded) between periods.(7)
A further limitation of the indexes
is their failure to account for changes in lending practices which have
reduced deposit constraints. Examples include the availability of mortgage
insurance to secure low-deposit loans; high loan-to-valuation ratio loans
which allow borrowers to take out a loan to cover all, or nearly all,
of the value of a property; and home equity loans that allow households
to borrow against the family home. These and other innovations in the
home lending sector have meant that persons previously unable to secure
finance have been able to purchase a home, which in turn has impacted
on the various measures of affordability.(8)
Concern about the various affordability
measures has led the Productivity Commission to comment that ‘the available
indexes all suffer from methodological and data problems that preclude
precise conclusions, particularly concerning first home buyers’.(9)
For these reasons, the indexes should be used more as indicators of
general trends, than as indicators of shorter-term cyclical movements.
The trend in home loan affordability
Home loan affordability has fluctuated
considerably over the past 20 years. Bearing in mind that a fall in
the REIA indicator denotes a deterioration in affordability, new home
loans, according to this indicator, were least affordable in 1989 when
the indicator was 28. That situation, however, quickly reversed and
by 1993, when the indicator reached a high 47, home loans were more
affordable than at any other time in the past 20 years. After falling
and then rising again, the trend since 1998 has been predominantly downward.
By 2006 the indicator had fallen to 30, a level worse than during much
of the 1980s, when interest rates were considerably higher than they
have been in 2006 (see Chart 1 and Table 1). The fall in the REIA indicator
since 1998, despite lower interest rates, coincides with a time of rapid
growth in house prices.
The CBA–HIA index similarly shows
that loan affordability was at a low in 1989 when the value of the index
was 112. Affordability improved thereafter, with the index reaching
a high of 176 in 1997. From 2001 the index has declined appreciably,
its value falling to an all-time low of 108 in 2006. Over most of the
last 20 years, there has been a significant gap in affordability between
capital cities and ‘other areas’, with the former much worse than the
latter. Interestingly, that gap has narrowed in the past few years,
indicating that house prices have been increasing faster in regional
Australia than in the capital
cities.
Table 2 provides a breakdown of
affordability on a state/capital city basis. Each of the indexes shows
that the least affordable home loans are currently in Sydney,
while the most affordable are either in Adelaide (REIA and BIS Shrapnel)
or Hobart (CBA–HIA). All the indexes show that the biggest deterioration
in home loan affordability over the past 20 years has occurred in Perth,
with the least deterioration in Adelaide (where according to BIS Shrapnel
affordability even improved over this period).
Sensitivity to interest rate rises
To assess the sensitivity of home
loan affordability to interest rate rises, an affordability indicator
has been developed for this Research Note that measures home loan repayments
as a proportion of average household disposable income. To calculate
the level of home loan repayments in any given year, it has been assumed
that the average loan size is the amount published by the ABS in Housing
Finance (Cat. No. 5609.0), the term of the loan is 25 years and
the prevailing interest rate is the variable bank rate for housing loans
as published by the Reserve Bank. The value of the indicator in each
year, for the past 20 years, has then been compared with what its value
would have been had the interest rate been one percentage point higher
than the prevailing rate. (See Table 3.)
As Table 3 shows, in June 1986 the
average homebuying household spent 22.1 per cent of its disposable income
on new home loan repayments at a time when the housing interest rate
was 15.5 per cent. However, had the interest rate been 16.5 per cent,
the average household would have spent an additional 1.3 per cent of
its disposable income on meeting new home loan repayments.
With each year after 1986, there
has been a gradual increase in the proportion of disposable income that
would have had to be spent to meet a one percentage point rise in interest
rates. In
other words, there has been a gradual
increase in the sensitivity of home buyers to interest rate rises.
The situation in June 2006 is such that an increase in interest rates
of one percentage point (to 8.55 per cent) would mean that the average
household would have to spend an additional 2.4 per cent of its
income to meet the increase in home loan repayments. If interest rates
were 10 per cent, then the average household in June 2006 would
have to spend an additional 6.0 per cent of its income to meet the increase
in home loan repayments.
Conclusion
Home loan affordability has fluctuated
considerably over the past 20 years, with affordability at one of its
worst points in 1989, a time when interest rates were at a record high.
After experiencing further rises and falls, there has been an appreciable
deterioration in affordability since 2001, a time when house prices
have grown rapidly. It is significant that in 2006 the affordability
indicator had fallen to a level comparable to that reached in 1989,
despite the fact that interest rates in 2006 have been very much lower
than they were in 1989.
It should be borne in mind that,
while providing a useful measure of the underlying trend in affordability,
the various indexes should be treated with caution when analysing shorter-term
cyclical trends. This arises mainly because the indexes are based on
median house prices and are therefore influenced by factors unrelated
to pure price change. Moreover, the indexes do not account for changes
in lending practices which reduce deposit constraints.
-
The only other measure of affordability is that produced
by the Australian Bureau of Statistics (ABS). This measure of affordability relates to all
existing home loans and is compiled on the basis of data collected
in the ABS Survey of Income and Housing Costs (SIH) which is conducted
every second year. For all home owners with a mortgage, the ABS calculates
housing costs (mortgage payments plus rates payments) as a
proportion of gross household income. The ABS measure of affordability
is not included in this Research Note as it is a neither a timely,
nor a widely reported indicator, nor is it consistent with the other
measures of affordability discussed in this Research Note. See ABS,
Housing Occupancy and Costs, 2003-04 (Cat. No. 4130.0.55.001),
p. 14.
-
A family is defined as a married couple with or without
dependent children. Median family income data are sourced from the
Census, with estimates for periods between Censuses derived on the
basis of movements in average weekly earnings. Loan repayment figures
are calculated from data provided by the Australian Bureau of Statistics, Cannex Pollfax and financial institutions across Australia.
-
Gross household income less income tax payable and other
payments to government.
-
In calculating ‘qualifying’ income it is assumed that
repayments cannot exceed 30 per cent of before-tax household income.
Qualifying household income is converted into qualifying disposable
income by using the ratio of household income to disposable income.
-
The median price of an established dwelling is obtained
from a census of CBA home loan approvals in a given period, adjusted
to approximate ‘first home buyer’ prices.
-
For a discussion of the limitations of the main house-price
measures in Australia, see Tony Kryger, ‘House Prices’, Research Note, no. 7, Parliamentary Library,
Canberra, 2006–07.
-
Productivity Commission, First Home Ownership,
Melbourne, 2004, pp. 25–30.
- ibid., p. 48.
- ibid., p. xv.
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