Higher interest rates have cut the maximum amount people can borrow and lifted their mortgage repayments but could ultimately benefit new homebuyers, according to a senior Reserve Bank of Australia official.
Jonathan Kearns, the RBA’s head of domestic markets, said the central bank’s rapid rate hikes have reduced borrowers’ maximum loan size by about 20% and lifted repayments by a quarter.
While the immediate impact was an increase in the cost of owning a home, Mr Kearns said over time the decline in demand for housing and therefore housing prices meant a household would need a smaller mortgage to buy a first home or upgrade.
“Estimates suggest the net effect is that mortgage payments for new buyers would be higher for about two years as a result of higher interest rates,” he told a property conference on Monday.
“But after that, the declines in housing prices and mortgage size begin to dominate.
“This exercise obviously abstracts from the many other factors influencing interest rates and housing prices, but it suggests that because higher interest rates reduce housing prices and so mortgage sizes, mortgage payments for new borrowers could ultimately be lower than if interest rates had not increased.”
The RBA has lifted the cash rate by 225 basis points since May to 2.35%, in the fastest hiking cycle since 1994.
Mr Kearns said the increase in mortgage interest rates will have reduced borrowers’ maximum loan size by about 20%, noting lenders apply a serviceability buffer 3% higher than the current rate in their loan assessments.
“And because the assessment rate also applies to any existing debt, the decrease in borrowing capacity is even larger for prospective borrowers who have existing debt, such as property investors.”
But he said only about 10% of borrowers take out a loan close to the maximum possible size.
“As a result, even if all borrowers’ maximum loan size is reduced by 20% in response to higher interest rates, not all new borrowers will have to take out a loan that is 20% smaller.
“For many borrowers, the amount they spend on a new home would decline only slightly or not at all (including because their savings to be used as a deposit need not decline with higher interest rates).”
Mr Kearns said the 225 basis point increase in mortgage interest rates also meant monthly payments on a new principal and interest 25-year loan will be around 25% larger, which can influence how much people want to borrow.
“It is important to note that this does not mean that all existing borrowers’ actual loan payments have increased by one-quarter,” he said.
About 35% of home loans are fixed-rate mortgages, and those borrowers will not face an increase in their interest expenses and loan payments until their fixed rate expires.
Mr Kearns said a large share of variable rate borrowers have been making excess mortgage payments into offset and redraw accounts.
“For many borrowers, these larger payments will mean that actual payments need not increase by the full amount of the change in required payments that result from the higher interest rate.”
‘Considerable uncertainty’ about rates impact on home prices
While the RBA has pointed to the possibility of housing price falls of 10% or 15% on the back of its rate hikes, Mr Kearns said the extent of the impact remains uncertain.
“Overall we know that higher interest rates will tend to depress residential and commercial property prices but there is considerable uncertainty about the magnitude and even the timing,” he said.
RBA modelling in April estimated a 200 basis point increase in interest rates would lower real housing prices by around 15% over a two-year period.
Mr Kearns said it was not a forecast but rather an estimate of how sensitive housing prices are to interest rates.
Noting that many other factors also influence housing prices, Mr Kearns said the impact of interest rates on prices depends not only on how much they change but for how long.
“If interest rates were assumed to be 200 basis points higher forever then this model suggests that housing prices would end up being around 30% lower than if interest rates had not changed.
“It is notable that these estimates based on historical data show that the change in housing prices occurs relatively slowly, certainly more slowly than for the prices of financial assets.
“The model also suggests that if interest rates reverted to their initial level after that two-year period, the interest rate effect on prices would be expected to eventually unwind.”
At a federal parliamentary hearing on Friday, RBA governor Philip Lowe said he expected housing prices to fall further as interest rates continue to increase and would not be surprised if prices fell by a cumulative 10%.
Mr Lowe noted that even then housing prices would still be up 15% over three years, after a 25% rise in two years during the pandemic boom.
Mr Kearns said RBA research found interest rates can have larger effects on housing prices in locations where the supply of housing is less flexible, mortgage debt is higher, there are more investors and incomes are higher.
He said the researchers found housing prices in the most expensive areas are the most sensitive to interest rate changes, adding there is some evidence that detached houses are more sensitive to rate changes than apartments.
“Overall this indicates that an increase in interest rates narrows the distribution of housing wealth since more expensive properties experience a larger fall in prices.
“But their results suggest that this distributional effect is temporary as the effects of interest rates on more expensive and cheaper properties converge over time.”