Research Note Index 2003-04

Research Note no. 20 2003-04

Interest Rates, Home Loans and Repayments

Stephen Barber
Statistics Group
24 November 2003

Introduction

On Wednesday 5 November 2003, the Reserve Bank of Australia (RBA) announced that it would be operating in the money market to increase the cash interest rate by a quarter of a percentage point (or 25 basis points) to 5.00 per cent.

Changes in the cash rateoften (mistakenly) called the official interest rateform the basis for the other interest rates in the financial sector. One group of interest rates that always draw most attention are those that apply to home loans.

With increasing speculation that there are further interest rate rises to come, this note looks at changes in the cash rate, home loan interest rates, the size of home loans and home loan repayment levels.⁽¹⁾

Cash Rate

In the deregulated financial system that operates in Australia, the RBAs most effective monetary policy instrumentto help form a sound basis for long-term economic growth by controlling inflationis through influencing short-term interest rates. It does this by operating in the overnight money market to set a cash rate target.⁽²⁾ The RBA has officially announced its cash rate target only since the beginning of 1990, see Table 1.

Table 1: RBA Monetary Policy Changes

Note: Monetary policy decisions are expressed in terms of a target for the cash rate, which is the overnight money market interest rate.

Source: RBA Bulletin

For the 17 months before the latest announcement, the cash rate had remained unchanged at 4.75 per cent. The previous change, on 5 June 2002, was also a quarter of a percentage point increase.

Home Loan Interest Rates

Prior to the latest change, the (predominant) interest rate of the banks on a standard home loan was 6.55 per cent; the rate on a basic loan was 6.00 per cent.⁽³⁾

Chart 1 shows the level of home loan interest rates since the Second World War. Generally, current rates are lower than at any other period since the end of the 1960s.

Home Loans: Sizes and Repayments

According to the Australian Bureau of Statistics (ABS), the average size of new home loans in September 2003 was $189 100. Table 2 shows the average size of new loans in each of the States and Territories for owner occupied housing issued by all significant bank and nonbank lenders. These loans include either construction of dwellings, purchase of new dwellings and purchase of existing dwellings (including refinancing).

Table 2: Size of New Home Loans (a)

(a)     Average for September 2003.

Source: Housing Finance for Owner Occupation, ABS (5609.0).

Over the last 15 years, the size of home loans has increased by an average 7.3 per cent each year; however, the increase over the year to June 2003 was nearly double that at 14.3 per cent. Only one other increase comes close to this: the 13.6 per cent increase between June 1998 and June 1999.

Table 3 shows the size of the average new home loan at June in each of the last 15 years. It also gives the size of the repayments on the loan at the interest rate of the time. It is interesting to note that although the loan size doubled between 1989 and 1999, the monthly repayments in 1999 were lower than in 1989; the amount of the repayments reflected the level of the interest rates: 17 per cent in 1989 and 6.5 per cent in 1999.

Table 3: Average New Home Loans and Repayments, 1989 to 2003

(a) On 25 year loan at interest rate existing at the time.

(b) Ordinary time earnings for full-time persons (converted to monthly).

Sources: Housing Finance for Owner Occupation, ABS (5609.0); Bulletin, RBA; and, Average Weekly Earnings, ABS (6302.0). 

More interestingly is the comparison of repayments to average earnings⁽⁴⁾ or an indication of income needed to service a loan. As is to be expected, a high proportion of income was required in the late 1980s and early 1990s but since then an average rate of 2829 per cent has been needed.

Over the last year, because of the large increase in average loan size, the proportion of income (30 per cent) is higher than the average for the previous 10 years and if the loan interest rate is increased by 25 basis points then the 2003 repayments amount to 31 per cent of income.

Loan Repayments Calculator

Table 4 shows the monthly repayments that are payable on various size loans at different rates of interest, assuming a 25 year term with interest calculated monthly.

Table 4: Loan Repayments

 At the previous home loan rate of 6.55 per cent, the monthly repayments on a loan with a principal of $100 000 is approximately $675. For the same loan at 6.8 per cent, the repayment is approximately $691.

The table can also be used to calculate repayments for loan sizes other than those shown e.g. a loan of $189 100 (average new loan from Table 2) at 6.5 per cent gives monthly repayments of (189.1 x $6.75=) $1276. The repayment on the same loan at 6.75 per cent (a rate rise of a quarter of a percentage point) gives repayments of $1307an increase of $31 per month. 

1. Also see recent related Research Notes: Tightening the Mortgage Belt by Peter Hicks; and, Mortgage Stress by Tony Kryger.
2. See Research Note No. 19, 199798, Reserve Bank Control of Interest Rates by Guy Woods.
3. A standard loan includes such facilities as a redraw option or ability to make early repayments, while a basic loan has very limited options. Source: RBA Bulletin.
4. A single income earner on average weekly ordinary time earnings for all employees (converted to a monthly figure). 

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