The Reserve will tend to talk hard but play it safe if they hike rates much further now.
As a general rule of thumb, I guess you can take the peak of your property’s valuation during COVID – when interest rates were near zero percent – and expect that to represent something of a high-water mark for a while.
Of course, in the short to medium term, prices are moving away from these levels and will continue to fall.
Why? Because if you make it more expensive to borrow, people can’t borrow as much for a given income, and less money borrowed means less spending at auctions.
That’s pretty obvious. Another less obvious factor currently weighing on borrowing power and house prices is the impact of generalized inflation on people’s borrowing power.
If you choose to take out a loan, your excess cash flow will be calculated as your income minus living expenses excluding housing expenses. The standard assumption for the cost of living – the so-called “Household Expenditure Measure” – is automatically indexed higher with inflation each quarter.
So if your annual after-tax income is $100,000 and the cost of living (excluding a home) is $60,000, you would have $40,000 in excess cash flow to pay for your new mortgage.
But inflate that cost of living by the full last inflation figure of 7.3 percent, and that brings it to $64,380, leaving you with just $35,620 in excess cash flow to service your loan — assuming your income doesn’t change .
So as you can see, even without rate hikes, borrowers have suffered a significant reduction in their ability to service loans due to the rising cost of living.
Add interest rate hikes, of course, and credit capacity has shrunk dramatically.
Rate hikes since last April have reduced the home purchasing power of the average full-time earner with a 20 percent deposit by 27 percent, from $600,000 to $440,000, according to AMP chief economist Shane Oliver.
Seen in this light, the 8 percent decline in home prices so far from their peaks early last year looks relatively modest. Oliver forecasts further price declines of about 9 percent until around September.
Much, of course, depends on where the Reserve Bank gets its cash rate from.
The money markets are still betting that the cash rate will rise to 4 percent from the current 3.1 percent. In this case, Oliver predicts an even sharper price drop of 30 percent overall.
Of course, only time will tell. I suspect the Reserve will tend to talk hard but play it safe by raising rates much further now, rather than raising rates only to have to lower them by the end of the year. An important “X-factor” remains how households with ultra-low fixed rates below 2 percent will react as the majority rolls off to rates closer to 6 percent this year.
Given the myriad forces at play, it is difficult to make any definite predictions. A final force is that our regulatory body, at the urging of lenders, has also shown a tendency to support property values with relaxed lending standards.
My guess is that if rates go much higher from here, there will soon be a lot of pressure to relax the current 3 percentage point stress test for new borrowers (that’s the test to see if borrowers can afford their mortgage, if interest rates were 3 percentage points higher than the current lending rate).
Some lenders are already pushing for longer repayment terms, with some having 40-year loans available, which means that monthly minimum repayments are falling, thereby increasing overall borrowing power.
So, buckle up because house prices continue to fall. But don’t be surprised if the results differ from the predictions. When it comes to home values, it’s anyone’s guess.
https://www.smh.com.au/business/the-economy/why-home-prices-are-falling-and-won-t-rebound-in-a-hurry-20230105-p5cai9.html?ref=rss&utm_medium=rss&utm_source=rss_business Why real estate prices are falling and won’t recover any time soon