Fairfax columnist, Malcolm Maiden, produced a tortured analysis over the weekend, telling generations X & Y to stop complaining about housing affordability:
You have probably seen reports recently that house prices have returned to record highs as a percentage of household income. The dollar value of debts that are being taken on to purchase homes is also therefore at record highs.
However as the chart shows, the relative cost of servicing home loan debt is lower than it was in the 80s and early 90s because home loan interest rates have fallen. It is actually in line with the average since 1980.
In 1989 an average Sydney house cost $170,000, and an average Melbourne house cost $132,000. Average annual earnings were about $26,400, and mortgages were priced at 17 per cent. Today, the median Sydney house costs about $873,000, the median Melbourne house costs about $610,000, average earnings are about $77,000, and the mortgage is about 5 per cent.
There are two caveats. The first is that rates will not stay low forever. Affordability will worsen if house prices don’t fall as interest rates rise. The second is that high house prices are creating dauntingly high housing loan deposits.
I hate this type of analysis. As you can see, Maiden has drawn his conclusions by comparing repayments on mortgages taken-out today against repayments during the period when mortgage rates were the highest in Australia’s history (see next chart).
This is misleading on a number of levels.
First, interest rates in 1990 did not stay at 17% for long and a home buyer back then got to enjoy the benefit of a massive drop in mortgage rates over subsequent years and a corresponding massive rise in house prices. Does anyone honestly believe that today’s first home buyer is likely to face similar conditions in the years ahead, whereby mortgage rates more than halve and values skyrocket?
Second, as noted by the Australian Treasury last year, average income growth is expected to be the weakest in at least 60 years over the coming decade, which is going to make paying-off today’s mega mortgage far more difficult (see next chart).
Third, when adjusted for inflation, real mortgage rates – 4.25% (discounted) as at December 2014 – are well above levels that existed prior to the early-1980s – a time when many baby boomers purchased their homes (see next chart).
Fourth, Maiden fails to mention that despite the lowest nominal mortgage rates in history, the humungous stock of outstanding mortgage debt has meant that today’s mortgage slaves are sacrificing a higher proportion of their disposable incomes servicing their mortgage debts (let alone principal):
As shown above, the proportion of aggregate household disposable income being sacrificed on mortgage interest repayments was 7.2% as at September 2014 – 17% above the late-1980s peak!
Fifth, while initial repayments on new mortgages are lower than the late-1980s and early-1990s, they remain well above the 40-year average (see next chart). Therefore, current housing conditions remain unfavourable, particularly given the coming shock to incomes.
Finally, Maiden fails to mention the sharp drop-off in home ownership rates amongst younger home owners – bonafide evidence of falling housing affordability (see next chart).
What should also become clear from the above charts is that the 1970s was a dream time to purchase a home. Not only were homes highly affordable at roughly three times incomes, but a purchaser was in the fortunate position to have had their debts inflated away via high inflation and centrally indexed wage rises that outpaced the cost of credit.
Of course, it was also the early baby boomers who benefited the most from these favourable conditions before enjoying the rampant house price inflation that followed. If only today’s home buyers were so lucky!