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Sydney’s Mortgage Loan Loan-to-value Ratio: Maximizing Property Profit
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The housing market is changing. It’s well known that prices fall as interest rates rise, but the structure of the market is also changing dramatically, and if you own—or want to—property it’s important to understand how the pieces make up the whole.
By forensically dissecting the housing market, we understand how it works and provide better insights into what will happen in the 2022 spring selling season—and 2023, when interest rates are predicted to peak.
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Let’s start with the prices. They fall, but not equally everywhere. Prices fell first in Sydney, followed by Melbourne, with those cities experiencing the biggest declines, as the next chart shows. Echoing the patterns of the 2017 home price correction, those markets were the first to fall and the first to recover.
Within the two largest capitals, prices fell first in the most expensive suburbs. In those suburbs, it is primarily established houses that change hands. At the same time, the cost of newly built houses is rising as input costs rise and manufacturers have no spare capacity.
Why are Melbourne and Sydney falling first? The answer is that loans are high in those two capital cities. As the next chart shows, the average new home loan is larger in Sydney and Melbourne:
As interest rates rise, larger loans become more expensive to service. This is important because the gap in average loan size is greater than the gap in income between states in Australia. People in NSW are more stretched by their mortgages and therefore more affected by interest rate rises.
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A rise in interest rates affects the appetite for credit, clearly. What types of loans are most affected?
As the next chart shows, investors and owner-occupiers can sometimes be in very different mindsets. For example, investors were increasing their share of the market in 2021 as owner-occupiers shrank. But in 2022, with rates rising much faster than expected, investors and owner-occupiers are taking out fewer and/or smaller new loans. The decline in owner-occupier lending is set for an unprecedented surge in 2020, so there are still some buyers out there even after a few months of contraction.
After enjoying a strong epidemic of many people moving into their first home, first-time homebuyers are joining the rush to get out. Loan volumes for first-time home buyers have fallen sharply to their pre-pandemic levels.
So what’s next for the housing market? If forecasts from Australia’s big banks go ahead, the market still has a way to go. Their home price forecasts are for a 15-20% decline, and the timeline they expect this to manifest is 6-18 months from now.
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Predictions can be wrong. The wisdom of crowds can, but market expectations are the best guess of what interest rates will do. But for what it’s worth, the market expects the official interest rate to rise to around 3.5% in 2023 before stabilizing or easing slightly. That would be another big hike in official rates from 2.4%. But of course official interest rates and what people pay on their mortgage can be very different.
As the next chart shows, there is a group of Aussies largely unaffected by the rate hike. They are the ones who took fixed rate loans in 2021. They feel nothing when the RBA raises rates. There are people who have taken fixed rate loans recently. Some of them locked in new highs. There are people with new variable rate loans: they pay more than fixed rates, but less than the luckiest group: people with older loans. The average interest rate paid on outstanding loans is higher than the average on new loans. This is why you should always consider refinancing: Banks profit from inertia.
When the RBA raises interest rates it tries to curb inflation. The mechanism is indirect: the central bank hopes to reduce household spending on goods and services by diverting household spending toward mortgage repayments and reducing household wealth through lower house prices. That reduction is intended to balance supply and demand so businesses don’t have to raise prices. (There are other ways monetary policy works: affecting household savings, the exchange rate, and business spending, but these are not relevant now).
Of the two main effects described above, house price declines are already occurring. But the transition of housing costs to mortgage repayments is slow. Even households with variable interest rates have a delay. Analysis from the Commonwealth Bank shows it takes two to three months for an official interest rate rise to affect a household’s mortgage repayments.
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During normal times these relatively short delays are not a problem. But when the RBA hikes by two percentage points in 91 days (from 0.35% on June 8 to 2.35% on September 7), it means they’re pointing more hoses at the economy before they get the water right. Extinguish the fire. The RBA says its actions will be guided by incoming data, but the data comes through a long lag and the bank is bracing itself before knowing the full impact of their actions.
This is what the RBA governor is talking about when he describes a path “cloudy with uncertainty”. Maybe they haven’t done enough yet. They may have done too much. We cannot know.
Watching the evolution of household expenses is now an adrenaline rush. ANZ Bank is building a series of daily spending that is yet to show a slowdown. But consumer confidence remains at deeply depressed levels. One of the two curves must be bent, depending on which one it is. If consumer spending collapses, the RBA may stop raising rates too soon. If not, the bank may have to raise rates even higher, which will affect house prices.
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It’s Jason Murphy
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