The Reserve Bank of Australia has lifted the cash rate for the second time in two months, this time by 0.50 points to 0.85%.
It won’t be the last such hike. Forecasters expect the cash rate to hit 2.5% by the end of next year. This would lift the typical variable mortgage rate to nearly 5%.
Cue the claims that the new generation of borrowers is entitled – they don’t know how good they’ve had it with such low rates.
But the refrain misses the full story. High house prices have changed the game, making it much harder for today’s borrowers.
Even a mortgage rate of 5% is well below the peak of about 17% earlier generations paid at the start of the 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.
Typical house prices used to be about four times income. Now they’re more than eight times their incomes, and more in Melbourne and Sydney.
This has meant that for any given mortgage rate, the share of income taken up by mortgage payments is much higher.
If you have a small loan with a high rate, all you need is cut in rates; some inflation, decent income growth, and your mortgage burden can fall sharply.
That’s how it was for borrowers in the 1990s. High rates stung, but not for long.
Borrowers in the 1990s who started devoting more than 30% of their income to paying off a mortgage found themselves saving just 12% by the time the loan was halfway through.
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 your mortgage payments can go – and that’s up.
5% would hurt like it didn’t use to
Even if mortgage rates stabilize at about 5% – implied by some of the things the reserve bank governor has said – and wages grow faster than they have for a decade, the mortgage burdens of millennials who recently bought houses won’t decline much.
The extraordinary increase in house prices and debt means mortgage rates of 7% would be as painful to borrowers today as rates of 17% were decades ago.
It’s a common barb that newer generations are struggling with home ownership and housing costs because of wasteful spending on smashed avos and the like.
But millennials spend less of their incomes on “discretionary” items – such as alcohol, clothes, and household services – than people of the same age did decades ago.
Millennials are spending much more on housing simply because houses are much more expensive.
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So as the reserve bank continues to increase rates, it’s important to remember that comparisons between then and now miss the full story.
Skyrocketing house prices have changed the game. For millennials, even historically small increases in interest rates will hurt.
