We all know house prices are starting to fall, but why?
There are many reasons quoted: the end of a long period of very fast price rises, increasing interest rates and a lack of confidence in the economy.
However, the really big reason that very few people talk about is the amount you can borrow.
This week interest rates were upped again when the Reserve Bank of Australia pulled the trigger, making it the sixth interest rate rise in six months.
The RBA’s latest 0.25% hike brings the cash rate to 2.60% and will continue to slash the borrowing ability of potential home owners.
Even though official interest rates are still well below previous peaks, these rises have a massive and leveraged effect on how much people can borrow.
That directly impacts how much people can pay for a property which, in turn, impacts how much people who are selling that property can ask.
Lower borrowings lead to lower prices
In very simple terms, the supply of money is being reduced, so the ability to support continuing boomtime price rises is being curbed along with it.
Very few people buy a house without a mortgage and it takes a long time to pay mortgages off – indeed, the latest census showed the proportion of houses owned outright without a loan has continued to fall.
That means the supply of mortgage money that can be successfully financed and serviced is a vital – perhaps, the most vital – measure of how high housing prices can rise.
This explains how the property market continued to boom even in the midst of COVID-19 lockdowns as the fall in the official cash rate to an unprecedented 0.1% effectively delivered hundreds of thousands of dollars in borrowing power to buyers.
Loan sizes slashed by hundreds of thousands
That process is very quickly reversing with the latest Canstar figures, which were prepared before this week’s latest interest rate rise, already showing that potential home buyers’ budgets have been slashed by hundreds of thousands of dollars.
The figures show a couple earning average incomes of $92,000 each can now borrow $264,000 less than they could have in April – mirroring the rise in the cash rate from 0.1% in April to 2.35% before this week’s rise to 2.60%.
The Canstar numbers show what a dramatic effect that has because even with a 20% deposit saved, the hypothetical couple’s maximum budget has dropped from above $1.63 million to just $1.37 million.
Even those numbers assume the buyers slash their living expenses dramatically.
That is the other side of the equation, of course: buyers not only need to get increasing loans to keep prices moving upwards, they need to service those loan repayments over the long term as well.
When mortgage repayments rise by 25% like they have since the five rapid fire rises, then all of those servicing housing loans are noticing they have less disposable income.
That is precisely how raising interest rates dampens demand and eventually reduces inflation because people run out of the ability to buy things.
Indeed, the 3% buffer that banks and other home loan originators use to measure home loan serviceability has effectively been ‘used up’ with the expected rise in the cash rate this week.
Number of loans falling as well
Not only are big loans harder to get, there are fewer of them as the market cools and people get cold feet about borrowing big or at all.
Australian Bureau of Statistics figures show the number of housing loans fell by 4.4% in June and by 8.5% in July.
Prices and activity are definitely slowing with clearance rates at auctions falling and values down since the peak by 5.7% nationally, and by 9.1% in Sydney and 5.6% in Melbourne.
Where will price go from here?
The really big question – and one which by definition nobody knows the correct answer to – is where home prices go from here.
Most of the banks are tipping total falls of around 15% to 20% but there are some outliers that go much higher, with economics research firm Digital Finance Analytics recently finding a “worst case scenario” in which interest rates that kept rising would see property prices fall by a whopping 43.5% by 2025.
That is factoring in a recession, of course, and some of the other milder scenarios it developed show falls to be much smaller – 23.7% by 2025.
Would the RBA keep raising rates in a recession?
What these and other models can’t do, of course, is factor in dynamic changes and reactions to what is happening.
Just looking at one variable, confronted by really rapid declines in property prices and rises in unemployment and loan defaults, the RBA would not go on happily raising interest rates further.
Instead, it would be cutting them, which starts to reverse the situation by increasing the amounts people can borrow and service – although with a significant time lag, just as we are seeing on the downside.
The future is inherently unknowable but history is some sort of guide and what it shows is that Australians will go to extraordinary measures to service their home loans and keep their house.
That probably means the worst-case scenarios being painted by some are quite unlikely to happen and that the eventual answer will lie somewhere around the middle of the host of ‘guess-timates’.
