First home buyers to suffer as RBA tightens policy

Economic Research Global Data Watch May 28, 2010

First home buyers to suffer most as RBA tightens policy

• Assertive RBA tightening now pushing interest rate burdens to pre-crisis levels • Pain for first home buyers lured by government stimulus will be most intense • Further rate hikes are likely owing to deteriorating inflation outlook

Australian mortgage holders have watched anxiously as interest rates have increased rapidly over the past eight months. One reason for this anxiety is that the transmission of changes to monetary policy has been direct. Indeed, commercial banks have lifted their variable loan rates by 25bp, or more, following each of the official rate hikes delivered by the RBA since October. Most mortgages in Australia are taken out on a variable-rate basis; fixed-rate loans accounted for under 5% of new loans issued in the past year. Households’ debt servicing costs, therefore, already have risen significantly. With market interest rates set to head higher as the RBA attempts to suppress an inflation threat, these interest burdens are set to hit historical highs.

Rate hikes already delivered are biting The assertive policy tightening has occurred as the RBA unwinds the emergency policy settings put in place in the midst of the global financial crisis. The RBA has lifted the official cash rate 150bp since October 2009. Early in the current tightening cycle, however, some local lenders increased their variable loan rates by more than the rise in the official cash rate. Standard variable home loan rates (SVR) rose by 160bp on average over this period.

The rapid pace at which the RBA stepped away from emergency settings caught many borrowers off guard, especially those who entered the mortgage market when interest rates were at generational lows. It seems many new borrowers overcommitted, and cracks have started to appear. Following the most recent rate hike in May, which took the average SVR to an 18-month high of 7.4%, confidence among mortgage holders slumped 8.1%m/m, nearly four times the drop following the five previous rate hikes in this cycle. Many borrowers appear to have crossed the pain threshold.

First home buyers to suffer the most Higher income earners and those who have owned property for an extended period are better positioned to deal with

Economic Research Note further rate hikes. They have more equity in their homes and, hence, lower mortgages as a multiple of their incomes. Investors also have watched property values rise significantly in recent years, particularly relative to first home buyers (FHBs), so have a substantial equity buffer. In contrast, lower income earners, many of whom are FHBs, will suffer the most as mortgage repayments continue to rise; their mortgages are large as a multiple of their incomes and as a ratio of the value of their homes.

Our analysis shows that FHBs’ higher leverage, combined with their lower household incomes, has increased their sensitivity to rate rises. The average loan size for FHBs was A$240,000 in the 12 months before the government expanded the FHBs’ grant in October 2008. The average loan size for FHBs rose to A$275,000 thereafter, until the expiry of the grant in December last year. In December, the loan size peaked at A$290,000. FHB demand has started to retreat, with FHBs accounting for just 16% of all loans issued in March, compared to a peak of 29% in mid-2009. FHB interest will remain depressed, with the RBA having hiked the official cash rate another 50bp since March.

Also, affordability is worsening. According to the Housing Industry of Australia (HIA), FHB housing affordability approached record lows in 1Q. The HIA housing affordability index dropped 28.7%oya in the March quarter, with mortgage repayments accounting for 25% of FHBs’ incomes.

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