How rising rates are impacting renters and owner-occupiers
For many Australians, 2022 has brought new financial challenges to our daily lives, not least in the form of problematic inflation and rising interest rates. The shift from outright deflation in 2020 to high inflation in 2022 has happened rapidly and somewhat unexpectedly. In June 2022, the headline inflation rate surged to 6.1 per cent per annum – the highest level since 1990 (excluding the GST introduction in 2000). This surge is due to a range of complex global and local factors, including geopolitical conflict; freight and supply chain disruptions; food production disruptions; interruptions to immigration flows; natural disasters; changing consumer demand patterns and temporary demand surges following lengthy COVID-19 shutdowns. Many of these sources of inflation are already subsiding as borders re-open and supply chain disruptions are resolved.[1]
Although some inflationary pressures are now receding, 2022 has seen prices rise across a wide range of goods and services. This indicates stronger demand across the board – and stronger demand than our economy has the capacity to supply. The RBA has responded to these circumstances with a rapid sequence of cash rate rises to dampen demand and nudge inflation down toward its target band of two to three per cent per annum, after an extended period of historically low rates.
Rising interest rates are often characterised as a blunt mallet rather than a finely tuned tweezer, but they are surprisingly effective in reducing aggregate consumer demand and hence inflation. This must be balanced, however, against the deceleration in activity (GDP) and employment that usually accompanies slower demand, deliberate or not. A small degree of income redistribution also occurs because people who derive income from interest paid on savings will get more income (e.g. self-funded retirees), but this will be outweighed in total by the higher interest bill that must be paid by all debtors.
It is worth noting that with no RBA cash rate rises since 2010, a high proportion of Australian adults haven’t experienced the impact of rising inflation and interest rates before. This lack of lived experience is probably a factor in explaining the surprise and even outright anger that many Australians appear to be feeling about rising interest rates in 2022. It might also mean their reactions are less predictable, with many people adjusting their spending to these new financial circumstances for the first time.
The way in which individuals adjust their household finances to rising rates depends upon their housing ownership status and debt levels, as well as their employment, income, other expenses and personal circumstances. Reactions can vary greatly in speed as well as depth. The RBA recently noted that significant delays are built into the ‘transmission system’ of interest rate changes at many key junctions (e.g. waiting for banks to adjust and apply their new interest rates to variable loans, waiting for fixed-rate loan tenures to end, or waiting for rental agreements to expire). Jonathan Kearns, Head of the Economic Analysis Department at the RBA said the total effect in housing and mortgage markets “tends to be drawn out, occurring over years rather than months”.[2]
Australia’s latest census counted 10.8 million private dwellings and 25.4 million people in August 2021. Of the 9.8 million dwellings that were occupied[3], 31 per cent were owned outright, 35 per cent were mortgaged and 31 per cent were rented (plus 3.4 per cent of ‘other tenure’ types).
Interest rate rises are affecting these broad types of households very differently:
31 per cent of homes are owned outright. This group of (often older) homeowners are largely unaffected by interest rate rises, unless they hold debts for other purposes. They may even benefit if they hold interest-earning savings. If they are also housing investors, then the interest paid on their housing investments will rise. This additional cost will need to be covered by their other income and/or passed on to renters if possible. Either way, the outcome will detract from aggregate consumer spending, as intended.
35 per cent of homes are owner-occupied with a fixed-rate or variable mortgage. For a typical variable-rate mortgage of $500,000, the latest rate increase of 0.5 per cent in September would have added $2,500 in annual interest payments, or $208 per month. The cumulative increase of 225 basis points so far this year will have added $11,250 in annual interest payments, or $937 per month in additional interest payments. For those on fixed-rate loans, this hit will be delayed until the end of their current loan tenure, but will then arrive in one huge increase, rather than in stepped increments.
PEXA’s research indicates that rising interest rates are prompting record numbers of mortgagees to seek refinancing in 2022. PEXA’s Refinance Index hit a record high in August 2022. PEXA’s Consumer Refinance Report indicates that already in May, over one million of Australia’s nearly eight million mortgage holders had refinanced their home loan in the previous year and 2.3 million intended to do so in the next two years (with 800,000 in both groups). 71 per cent of mortgage refinancers were ‘anxious about rising rates’ and 51 per cent were mainly or partly motivated by the desire to find a lower rate.
31 per cent of homes are rented. Advertised rents are already rising sharply nationwide, with rental vacancy rates at record lows in many locations. This is hitting those currently seeking a new rental property earliest and hardest. For established renters, rental agreements in Australia tend to be around 12 months tenure on average. This gives them only a short delay before their rent is likely to increase.
For renters who aspire to be first home buyers, the journey to home ownership will inevitably take longer with higher interest rates. House prices might fall a touch, but their maximum loan size will be significantly smaller. The RBA recently calculated that the 225 basis point increase in interest rates since May 2022 “will have reduced borrowers’ maximum loan size by around 20 per cent … and monthly payments on a new (principal and interest 25-year) loan will be around 25 per cent larger”.[4] This will inevitably result in fewer people moving from renting to owning, and at lower average price points.
References
[1] RBA Causes of Inflation. https://www.rba.gov.au/education/resources/explainers/causes-of-inflation.html
[2] Jonathan Kearns, Interest Rates and the Property Market, RBA speech to AFR property summit, 19 Sep 2022.
[3] As an aside, just over 1 million unoccupied (but apparently habitable) dwellings were identified on Census Night 2021, or 10 per cent of the total. Other homes had fewer people in residence than bedrooms. Much speculation has arisen about these underutilised properties and whether they could help alleviate local housing pressures. There are many reasons why an individual property or bedroom may have been empty on census night however, so more research is needed in order to identify residences that are truly underutilised, the reasons behind it and the policy options that might be available to improve housing mobility.
[4] Jonathan Kearns, Interest Rates and the Property Market, RBA speech to AFR property summit, 19 Sep 2022.
