The housing game has changed – why interest rate hikes hurt more than before

The Reserve Bank raised the key rate for the second time in two months, this time by 0.50 points to 0.85%.

This will not be the last hike of this type. Forecasters expect the cash rate to reach 2.5% by the end of next year. This would bring the typical variable mortgage rate to almost 5%.

Cue the claims that the new generation of borrowers have – they don’t know how bad they got with such low rates.

But the chorus misses the whole story. High house prices have changed the game, making it much harder for today’s borrowers.

It’s true that even a 5% mortgage rate is far below the peak of around 17% paid by previous generations in the early 1990s.

But the impact of those high rates on overall mortgage interest payments as a share of income was modest, because house prices were much lower then and mortgages were much smaller.


The projection is for December 2023. It uses the average mortgage interest rate in December 2021 and assumes that the household debt ratio is stable at December 2021 levels.
RBA tables E2 and F6; ABS national accounts; Analysis by Gratan.

Typical house prices were about four times income. Today, their income is more than eight times that of Melbourne and Sydney.

This means that for a given mortgage rate, the share of income spent on mortgage payments is much, much higher.


Each point represents a period of 3 months.
Source: RBA Tables E2 and F6

If you have a small loan with a high rate, all you need is lower rates, some inflation and decent income growth, and your mortgage load can drop sharply.

That was how it was for borrowers in the 1990s. High rates stung, but not for long.

Borrowers in the 1990s who started spending more than 30% of their income on paying off a mortgage found themselves spending only 12% halfway through the loan.


Assumes an 80% LVR loan over 25 years on the average house price in the year borrowed, taken from Yates (2011) for the period before 2010, and ABS thereafter. No mortgage insurance from lenders. Income is the gross disposable income from the ABS National Accounts. Historical interest rates are 3-year moving averages of standard variable rates (discounted from 2004). The projected interest rates are the average of the last 10 years. Projected revenue growth is 3%.
Sources: ABS national accounts and residential housing prices; RBA Table F6; Yates (2011); Gratan Analysis

It’s different if you’ve borrowed recently.

If you’ve taken out a big loan at today’s ultra-low interest rates, there’s only one way to make your mortgage payments – and that’s up.

5% would have pain as before

Even if mortgage rates stabilize at around 5% – which is implied by some of the Reserve Bank Governor’s statements – and wages rise faster than they have in a decade, mortgage charges for millennials who have recently purchased homes will not. a lot of decline.

The extraordinary increase in house prices and debt means that mortgage rates of 7% would be as painful for borrowers today as rates of 17% were decades ago.

It’s a common barb that newer generations struggle to access home ownership and housing costs due to overspending, crushed lawyers, and the like.



Read more: Paying off a home loan used to be easier than it looks. It is now more difficult


But millennials are spending less of their income on “discretionary” items – such as alcohol, clothing and household services – than people of the same age decades ago.

What millennials spend a lot more on is housing, simply because houses are so much more expensive.

So, as the Reserve Bank continues to raise rates, it’s important to keep in mind that comparisons between yesterday and today miss the whole story.

Soaring real estate prices have changed the game. For millennials, even historically low increases in interest rates will hurt.

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