One of the more common questions asked of me during my last Master Class workshop session earlier this month was “When will this crazy sh*t stop?”.
In other words, when will the RBA and APRA start applying the brakes?
So, this week lets cover this question.
Chart 1 shows that the current official interest rate setting is inflationary.
It isn’t a question of if interest rates will rise, but when and by how much.
When, for mine, depends on the timing of a federal election. November this year or in the first half of 2022? Coin toss maybe. But Morrison has been doing the overseas tango and is apparently on a diet. Late this year me thinks.
The RBA – again for mine – will start lifting the cash rate in 2022. The first lift is likely to be in February if we have a 2021 election or in May or August depending on when we go to the polls during 2022.
The later they leave the first lift the more likely we will see several 0.25% monthly repeat touches on the interest rate brake.
By how much interest rates rise is much harder to guesstimate.
Yet smarter heads than I am are suggesting that the cash rate (which is a record low of 0.15%) needs to lift by at least 2.5% within the next year or two to keep future CPI within the RBA inflation target range of between 2% and 3%.
Assuming we see a 2.5% lift in the cash rate and all of that rise is passed onto borrowers, then we are likely to see a doubling in the annual mortgage rate from the current average rate of 2.5% to 5%.
A $500,000, 30 year variable principal and interest loan, which at the current average mortgage rate of 2.5% per annum equates to a repayment of about $2,000 per month.
At 5% per annum this loan will cost the borrower $2,700 per month; a 35% increase. These borrowers will need to find another $8,400 (net) each year to pay their mortgage.
Yes, you can get home loans cheaper than 2.5% at present, but the story remains the same, being that within the next 12 to 24 months many mortgage holders will be paying much more for their homes or investment properties.
It is true that the impact on those that have recently borrowed monies to buy a dwelling might not be that bad – assuming the circumstances above – as many new loans would have been assessed on a repayment schedule 2% to 3% higher than the actual borrowing rate at the time of the loan. Having said that, such an assessment is often quite different to what one can actually afford and especially on an ongoing basis.
Moving forward – assuming the base variable home loan rate of 5% per annum -many new home loans will be assessed on a 7% to 8% annual rate, bringing the assessed monthly repayments on a $500,000 variable P+I home loan to around $3,500 per month.
To meet this criteria many future borrowers will need to have a $150,000 annual household income. At present an annual household income of around $110,000 is enough to secure a $500,000 home loan.
At present approximately 40% of Australian households can borrow $500,000 to buy a home. A 2.5% lift in mortgage rates will reduce this number of potential households to just 9%.
Of course, interest rates don’t have to rise to slow the housing market, APRA can do much of this heavy lifting themselves and they could tighten things much earlier than RBA too.
But again, for mine, their energy levels are likely to remain subdued until after we go to the federal polls.
Tough love is coming. A housing slowdown is on its way. It needs to happen. And I expect that there will be some blood on the floor.