Research Note Index 2003-04

Research Note no. 21 2003-04

Tightening the Mortgage Belt

Peter Hicks
Economics, Commerce and Industrial Relations Group
24 November 2003

Introduction

The recent decision by the Reserve Bank of Australia (RBA) to increase interest rates following seventeen months of unchanged, historically low rates has generated interest in the impact of this decision on the approximately 32 per cent of Australian households with mortgages.⁽¹⁾ It has also prompted speculation about further rate rises in the next few months.

This Research Note updates previous IRS research from early 2001 which estimated that the size of the average mortgage was considerably less than the figure used by some commentators at the time.⁽²⁾ It also assesses the impact of the recent interest rate rise on both first home buyers (FHBs) and repeat buyers (RBs) who have taken out loans in the last ten years. Readers' attention is also drawn to other recent Research Notes on housing.⁽³⁾

New Versus Average

Despite the efforts of the Governor of the RBA⁽⁴⁾ to focus attention more on the average of all mortgages in existence rather than the average new mortgage (i.e. for the latest month available), the erroneous tendency for commentators to look only at the impact of the recent rate rise on the average new mortgage persists. Examples of the description of the impact of the rate rise in the media include 'the interest payable on variable home loans will rise by about $30 a month for a 25-year, standard $200 000 mortgage'⁽⁵⁾ and 'the cost of servicing your average mortgage went up $30 a month yesterday'.⁽⁶⁾

However, a more accurate and appropriate basis for analysis and debate is provided by the average mortgage which covers all loans in existence regardless of when they were taken out.

Growth in New Mortgage Size

Table 1 shows the average new mortgage has increased in each of the last ten years except 2000-01 for both FHBs and RBs.

Table 1: Number and size of new mortgages, and housing interest rates 199394 to 200203

 1. RBA indicator rate for variable rate bank mortgages.

Sources: ABS Housing Finance for Owner Occupation (cat. no. 5609.0) and Reserve Bank of Australia Statistical Bulletin, various issues

Using the same methodology as previously,⁽⁷⁾ from Table 2 it is estimated that the average FHB mortgage is currently in the range $118 000 to $123 000 while for RBs it is in the range $127 000 to $132 000. Again this is much less than the figure typically used in media reports.

Table 2: Summary of new mortgages 199394 to 200203

 Source: Derived from Table 1.

Table 1 also shows that the surge in the size of new loans is not just a recent development. The average mortgage size for all borrowers has increased at an annual average of over 8 per cent since 199596.

Impact of interest rate increases

On 5 November 2003, the RBA increased the cash rate by 25 basis points to 5.0 per cent. This has resulted in the indicator standard variable interest rate for bank housing loans increasing from 6.55 per cent to 6.8 per cent.

Table 3 shows that homebuyers who took out their loan during the five years 199394 to 199798 will, on average, be paying an extra $15 per month while for those who took out their loan between 199899 and 200203 the increase in repayments will average $23 per month. For the average mortgage, the increase will be about $19 per month. Again this is significantly lower than the figure used in media reports.

Table 3: Impact of November 2003 interest rate rise

Source: Derived from Table 2.

 The repayment increases shown in Table 3 are based on the assumption that all borrowers have only been making the minimum interest rate rise repayments on their loans. However, as reported previously⁽⁸⁾ it is common practice for borrowers to make repayments ahead of the scheduled minimum level, especially when interest rates fall, thereby establishing a buffer against future rate rises.

There are a number of strong indications that the majority of borrowers have such a buffer:

• nearly 60 per cent of borrowers in the decade to 200203 borrowed at interest rates in excess of 6.8 per cent (see Table 1) and history suggests they are very likely to have left their repayments unchanged when rates fell⁽⁹⁾
• just over half of the households who bought their first home in the three years to 1999 were making above the minimum repayments,⁽¹⁰⁾ and
• recent reports conclude that the average home loan customer at National Australia Bank was 20 per cent ahead of repayments and most bank borrowers were ahead of their mortgage repayments.⁽¹¹⁾

Other factors which will affect the impact of the rate rise on borrowers include whether they have a fixed rate loan⁽¹²⁾ and whether their loan agreement provides for interest rate changes to be applied to the actual or scheduled balance outstanding.

Mortgage Affordability

Despite recent concerns expressed by the RBA about trends in housing related household debt, it is worth noting that mortgage repayments have accounted for a declining share of the gross income of house purchasers during the 1990sdown from 20 per cent in 1990 to 17 per cent in 19992000.⁽¹³⁾ All income groups recorded a fall. Given this and the above discussion on the impact of the rate rise, a little tightening of the mortgage belt is likely to be quite manageable for the average borrower.

This Research Note has canvassed the financial impact of last month's interest rate rise on existing mortgage holders. However, possibly of greater importance, is the extent to which expectations about the amount and timing of any further short-term rate increases will affect the future borrowing patterns of existing and potential mortgagees.

During the last ten years 17 per cent of borrowers have taken out other than variable rate mortgages. These households, that is about 5 per cent of Australian households, may therefore not be immediately affected by the rate increase.

1. Peter Hicks, 'Trends in mortgages', Research Note no. 22, Department of the Parliamentary Library, 200001.
2. Stephen Barber, 'Home Loans: Size, Interest and Repayments', Research Note no. 20, Department of the Parliamentary Library, 200304.
3. Tony Kryger, 'Mortgage Stress', Research Note no. 16, Department of the Parliamentary Library, 200304.
4. See Mr Macfarlane's comments to the House of Representatives Standing Committee on Economics, Finance and Public Administration, 31 May 2002, p. 19.
5. Morgan Mellish, 'Rate rise: RBA taps the brakes', Australian Financial Review, 6 November 2003, p. 1.
6. Mike Seccombe, 'Security makes grist for the scare mill', The Sydney Morning Herald, 6 November 2003 p. 6.
7. Peter Hicks, op. cit.
8. ibid.
9. Matt Wade, 'Mortgage rate rises eat into borrowers' payments buffer', The Sydney Morning Herald, 28 August 2000, p. 39.
10. Australian Bureau of Statistics 'Housing and lifestyle: First home buyers', Australian Social Trends, 2003
11. Lisa Murray and Joyce Moullakis, 'Borrowers well aware it was on the way', Australian Financial Review, 6 November 2003, p. 7.
12. Over the last decade about 12 per cent of loans have had fixed interest rates.
13. Treasury 'International House Prices' Economic Roundup, Autumn 2003, pp. 111129.

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