Why rising interest rates means falling house prices

The ABC published an article neatly explaining why rising interest rates necessarily means that house prices will fall.

To cut a long story short, a higher interest rate lifts monthly mortgage repayments, which in turn limits the amount that a prospective home buyer can borrow.

The ABC cites the real world experience of the Chamberlain family who were pre-approved for a $975,000 mortgage in late 2020, but have since had their borrowing limit cut back to $750,000 due to the Reserve Bank of Australia’s (RBA) rate hikes:

The Chamberlains weren’t expecting their estimated loan amount to drop down from $975,000 to below $750,000 when they went back to their broker last month.

The couple’s deposit hasn’t changed since late 2021 and Mr Chamberlain actually received a slight pay raise recently.

“(Our broker) was pretty open with us about saying it was all down to interest rates,” Mr Chamberlain said…

“Clearly, higher interest rates are eroding borrowing capacity,” CoreLogic’s Tim Lawless told ABC News…

Mortgage broker Bruce Carr describes the current property market situation as a “feedback loop” where it is not necessarily easier for people to buy a home as their borrowing capacity diminishes.

The reduced borrowing capacity can be illustrated via a mortgage calculator.

Before the RBA began its monetary tightening cycle in early May, Australia’s average discount variable mortgage rate was 3.45%.

After yesterday’s 0.5% official cash rate (OCR) increase from the RBA, the discount variable mortgage rate will rise to 5.20%, which implies a 23% increase in mortgage repayments versus their level in April before the first rate rise:

Australian mortgage repayments - current

Debt servicing levels have already lifted by nearly one quarter.

Put another way, the increase in mortgage rates has already reduced borrowing capacity by 23%, other things equal.

The ANZ, Westpac and the futures market are tipping the RBA to hike the OCR to around 3% by year’s end (latest futures market forecast below):

Market interest rate forecasts

Futures markets are still tipping aggressive interest rate hikes.

If the futures market’s peak OCR of 3.3% came to fruition, this would imply an average increase in mortgage repayments of 38% versus their level in April 2022 before the RBA commenced its tightening cycle:

Australian mortgage repayments - projected

Debt servicing cost to rise further.

The above data illustrates why interest rates are the biggest short-term driver of house prices, and why the aggressive monetary tightening from the RBA will necessarily drive Australian house prices sharply lower.

Interest rate hikes raise the cost of debt, lower borrowing capacity and in turn stymie buyer demand. No other factors come close.

Unconventional Economist

Comments

  1. If you and CJ and all the other economists are so concerned about the impact of rising rates on housing, why don’t you focus on the banks? Why the need for such margins? Just have a .5% on the RBA cash rate for variable. They can fight it out on fees etc. Shouldn’t be an issue to normalise rates in this cycle.

  2. Water is wet.
    I’m more interested in what this means for bank valuation of their property collateral against loans. If lending sets values it follows that crunching pre-approvals drives the entire assets on their books lower and we have underwater homes.

    What forces a reconciliation /mark to market event?
    1. For the bank?
    2. For the borrower?

    • New applications for credit are the mark to market event for home owners.
      My partner worked in Geelong as an arrears officer with a prominent big4 bank with a yellow logo, in the early 1990’s with the Pyramid mess. She sent plenty of files to “legal” for foreclosure.

      Her position from seeing how this works from the inside is don’t apply for credit. Once the bank got out your file and reviewed it, everything was on the table. Applications for credit, store loans, Afterpay are all red flags in this environment.
      If your file is left in the archive, nothing to fear provided your LV ratio is comfortably below the 80% mark.

      I have heard from colleague in WA, back around 2015/16 banks were hitting up mortgage holders for mortgage insurance when properties previously below, but close to 80% were revalued down by the bank. The one case I’m thinking of, the bank requested either a cash collateral top up or the borrower was forced to take the banks in house mortgage insurance. The premium was higher than the monthly mortgage payment itself, effectively doubling monthly repayments.They couldn’t refinance with anyone else, thus had to pay.

      In this way, the banks can extort mortgage holders who have jobs to, in effect pay for the losses on properties suffered by the bank by foreclosure for those that either lose their jobs or can no longer make the repayments.

      • Interesting, though the bank would have to be very selective and quiet around that ex post LMI fee. In an environment where a decent chunk of borrowers would be subject to negative equity and where the current govt would be under huge pressure owing to economic conditions, the banks risk the full wrath of a populist backlash.

        Balance of probabilities suggests they will play the long game and focus on ensuring repayment cash flows. But who knows!

        • Interesting, though the bank would have to be very selective and quiet around that ex post LMI fee. In an environment where a decent chunk of borrowers would be subject to negative equity and where the current govt would be under huge pressure owing to economic conditions, the banks risk the full wrath of a populist backlash.

          Yep this was on the “downlow”, it appeared to be at the individual borrower level. The borrower in question had a stable high income position, so ripe to be targeted. it was an n=1 anecdote, but I distinctly remember being absolutely blown away at the audacity of the situation. It seemed like an outright reverse bank robbery.

          Then again, I’ve read a few interesting books & papers on the US 1980’s S&L crisis*, so maybe my judgment is tainted & jaundiced at the astonishing levels of abuse that can be imposed by those in control, for profit.
          * See reference list : Looting The Economic Underworld of Bankruptcy for Profit

          • This from another MB article today:

            The NAB is getting real-time data on whether its customers’ wages are going up, down or sideways…

            It’s the first time the bank has used its customers’ data in this way. So, it began with the deposit account data of roughly a million customers, and its computer models whittled that down to 250,000 customers that has straightforward, measurable wage or income deposits.

            Its results are remarkably consistent with the ABS’s results on wage growth.

            That is, NAB’s analysis has found wage growth increased 2.5 per cent in the three months to June — up 0.1 per cent on the ABS’s measure for the March quarter. In other words, wage growth, it reckons, is barely budging.

            This is contradictory to what the Reserve Bank is reporting.

            source: ABC Australia’s inflation figures are clear, but when it comes to official wages data, we might be flying blind

            So they have the income data in real time,, they have the real estate valuation, in real time. Not difficult to write some code to figure out which borrowers can be “squeezed” to subsidise any losses.

            Is there anything that prevents the banks doing this? They appear to have high LV ratio borrowers over a barrel. Then you get the whole negative equity spiral, as you now can’t pony up the cash difference to enable the property to be sold if you want to stay out of bankruptcy.

            Good job, high LV mortgage or negative equity? You might now the banks best asset.

      • I’m from Geelong. Everyone knows someone that was burned by Pyramid.

        Personally I don’t own property or have a mortgage, but my pensioner father has a small mortgage remaining. I have been tipping in extra payments here and there to ensure it is always ahead and there’s never a reason for the bank to look at it.

  3. SkepticviewerMEMBER

    While I agree that some areas of house purchase will be affected, different areas for sifferent reasons will not be. The increase in mass immigration which is a primary driver in terms of both lack of supply and extreme demand for purchases and rentals will keep prices extremely high.
    Other people come with different motivations renting out six to a room at 250 a room in a substandard house is nothing to them. and obtaining as many houses as possible makes them millionaires in a short time frame. Each room renter hopes to move their family to Au live so staying in a dive is a small price to pay for millions in dividends later. Then the Airbnb people and the speculators who buy rundown in areas of future high demand usually with the help of insider info.
    The ordinary Australian who just wants a house so they can have a family is almost as dead as the Dodo what is left of them can no longer afford a loan. We import families now and we do that to 1 crush wages, 2 keep house prices high and three avoid accountability by passing the blame on to the housing market – a market so far distorted as the almost be a commie Marxist Capitalist masterstroke. Control via impovertisment.

      • SkepticviewerMEMBER

        If you have the money and mates then yes. Of course in Australia, there is no corruption, not one little bit so knowledge of road/rail building and rezoning etc can’t be had for the cost of a breakfast, here don’t worry about that. If you get the nod that mass third-world immigration is sacrosanct then your on a winner.

    • Anecdata would support this in Geetroit:)
      Wouldn’t surprise if developer types had mates at morgue or palliative care.
      Whole blocks of EMPTY houses. Some shrouded in temp fence – get a sh1t makeover then drip fed to rental market to support asking prices. Rental applications akin to submitting bank loan but more invasive with extra dollop of humiliation.
      A mate in Hawthorn commented on cultural appropriation ie 20-60 something wives of SIV holders trotting around in LULULEMON active wear carrying $5000 puppies. Hilarious all over GEETROIT as well not just Belmont but NEWCOMB NORLANE & CORIO:)))))

      • I’ve heard rumours that there is an investor in the former housing commission areas mentioned (mainly Corio and Norlane) that owns something like upwards of 50 houses. I’m curious who, why and what’s the actual long term plan?

        As you probably know, solidly built on generous sized blocks. I’ve wondered if there might be a land assembly, rezone, retitled on smaller blocks, doze the lot, start again sort of thing. Might also just be an “Underpants Gnomes” strategy.
        1. Buy all the houses
        2.????
        3. Profit!

  4. What Mr Chamberlain hasn’t figured yet, is the bank may be doing him a favour. I’m guessing his wage hasn’t dropped, so if he has a small modicum of patience, in 6 mths the market catches down to his approval limit and he will be better off by 200k.
    But no, we want it now !
    Some people deserve to see the arse drop out from under their largest asset, so they get a free life lesson ffs

    • With borrowing capacity dropping ~20%, and house price declines sitting at ~3% so far, Mr. Chamberlain has the FOMO well and truly. Not too many people are calling for large drops in house prices. But they are calling for higher interest rates, which to Mr. Chamberlain means that the borrowing capacity will be dropping even further, driving FOMO to eleventy.

      I do not see it as “wanting to have it now”.

      I’m sure Mrs. Chamberlain doesn’t help, with a young child and such 🙂

      • Too soon.
        Rate hikes will stop soonish, house prices will catch down to a point cos they wont just stop. The % down we are seeing is 6 weeks old, agent are talking 10-15% down currently.
        Credit numbers in the next few months will tell the story, they weren’t flash a few days ago.
        Maybe if he explained to Mrs. that a 1m house now could be worth 850k early next yr she might hold off, or maybe not ……..

  5. Reduction in max amount that can borrowed will only cause house price falls when a critical mass needs / wants to borrow at close to regulatory capacity. Which may well be and likely is the case atm but it is a critical condition

    • Arthur's Poodle

      There are two factors:
      1. What a party can borrow
      2. What a bank values the property at

      A banks lends money against an asset. If a property is valued at $1,100,000 all of the big four will lend up to that amount.

      This is most evident when builder/developers on a bid on a site at auction. Most will drop out on or just over the maximum the banks/finance company are willing to lend against a particular site.

      Why ? Because most Aussie developers, investors and owner occupiers borrow to their limits.

      The exceptions are all the shutins who comment in disbelief 🫢 on MB! 😆👍 (including me 🤣)

      ‘Straya! Mis-allocating capital for 40 years!

  6. …and this would all be a non event had APRA maintained its assessment rate floor at 7% . Plenty of blame to go around among regulators ( yes you RBA for your TFF billions) but they are putting out a fire entirely of their own making.

      • Yeah wouldn’t that be livin’ the dream
        I just shake my head when friends fixate on housing, ffs it’s shelter nothing more nothing less. Shelter is necessary for sure, but important? not really.
        I’d hate to have my life and life’s achievement defined by a house that I bought at some point along the line, but worse still would be a life that couldn’t get started because you couldn’t secure shelter for your family. It’s all so beyond F’ed up. It needs to just burn to the ground
        Australia need this whole housing speculation craze to just end, somehow we need to begin the honest search for creating real wealth…and for that matter a real lives.

          • Yep I had this discussion with a nephew just the other day.
            All of his friends are telling him to buy a house quickly (while it is still possible)
            So I said to him think about what that means (while it is still possible)
            Do you want to live in a country where (for the next generation) owning a house is simply not possible.
            What kind of a F’ed up place would that be.
            The goal of home ownership needs to be always possible, sure there will always be those that miss out but for the majority, it simply needs to be achievable. Otherwise we devolve into Feudalism…probably to be followed by some sort of civil unrest and even civil war.
            It’s just beyond ridiculous to believe that any society can prosper by denying hard working citizens shelter.

        • I just hate those who are dumb but talk up housing investment and tell me how many properties they are going to own, but can’t explain negative gearing, or CGT discount….guess I’m also frustrated cos I would have bought an IP in 2015 but read this blog, ewwwwww…would be sitting pretty comfortable right now

          So will they continue to be right? I’m going to look out for signs of increased mortgage commitments then jump in!

          • Clearly you want to be part of this IP trend, so just do it.
            I on the other hand don’t have no interest what so ever in owing an IP
            I do however maintain an active interest in investing and I’m always on the look out for any investments in Australian tech industry that I can justify. It just sucks that housing is so critical that many of our brightest engineers and scientists are forgoing a career in this field because (due to their housing commitments) they can’t afford to take other risks.

          • Mate I agree, but the tax advantages are a joke for property

            I would prefer to put in stocks, picking the bottom of this cycle would see excellent gains, but margin lending is very risky

        • SkepticviewerMEMBER

          Absolutely – In fact it is passed time that a responsible government simply ended the whole thing. One house only per purchaser everything else could be placed in a business subject to regulation and inspection. No passport no purchase full stop – no allowing third world students to buy houses while they are here or the parents of international temp high school students buying houses – ban Airbnb in domestic areas and ramp up social housing and ramp down mass third world immigration. End the speculation of the golden visa holders and simply end all the other rorts and the rip-offs. It could all be done with a pen. Give Australians a chance to rebuild their self-reliance and industrial backbone. Enable the greater mass to have something of their own and thus feel engaged with the country not alienated from it or struggling to afford to live in it .Mostly this status quo appears to be due to the pandering to overseas wreckers instead of any loyalty to the population, all past PMs in the last twenty years are hollow shells, to the detriment of the nation. Gillard had promise but folded badly when pressured.
          The damage being done by poor housing and rental stress together with insecurity will have a very negative effect on the view that young people take moving forward and vengeance is all I think that they will have on their mind certainly not having families or innovating or community participation

  7. So we’re fighting inflation with the cash rate.
    However, the nature of the inflation we’re experiencing isn’t directly linked to the cash rate.
    The largest impact of increasing rates is to push up the cost of borrowing and reduce borrowing capacity.
    This cripples the largest play in the Aussie economy (as far as households are concerned).
    As a result, consumer spending is getting smashed, driving down economic activity.
    Meanwhile, wages aren’t growing anywhere near the rising cost of goods and services, nor to service debt at higher rates.
    Rate rises seem to trigger currency weakness, exacerbating the problem.
    Thus far, we’re yet to see a single action outside changing the cash rate brought to the table.
    And somehow all this is meant to fix the thing?

    You will have to excuse me if I’m confused and dismayed by the situation, but as far as I can tell we’re completely f’ed. There are no good ends here, just different flavours of merde to plate up.

    • Its better than the alternative. The alternative is – (1) look through the inflation because we have no control over it, then (2) cut interest rates to stimulate the economy, then (3) currency goes down the chitta = (4) end up like Srilanka.

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