There’ll be a new, and unwelcome, topic of conversation at many family gatherings in Australia this Christmas – ‘negative equity’. That once unthinkable situation where the size of a person’s mortgage exceeds the value of their home.
Sadly, negative equity is now emerging as a real prospect for many Australians who purchased their homes in the last twelve months.
Their dilemma was exacerbated last week when the Reserve Bank of Australia (RBA) hiked the cash rate for the eighth time since May. The rate has now risen this year from a low of 0.1% to a decade high 3.1%.
The only good news is that the board of the RBA doesn’t meet in January, giving borrowers a brief reprieve.
According to Graham Cooke, head of consumer research at Finder, the latest RBA hike means that “the average home loan rate has jumped from the mid-3s to the mid-6s”. Cooke says that to “comfortably afford” a $500,000 mortgage will now require a minimum income of $180,000. The comparative figure back in April was just $121,000.
And three of the four big banks are predicting that the RBA will increase the cash rate next year by at least another 0.5%. That would mean interest rates on many home loans starting with a 7, a level unimaginable to first home buyers in recent years.
Many Australian home loans start with a fixed interest rate and then after a pre-determined period (usually 1-3 years) convert to a variable rate. The gap between some of those historical fixed rates and current variable rates has now blown out dramatically. That spells trouble for many borrowers when their loan converts.
During 2021, the initial fixed interest rate on home loans dropped to as low as 1.95%. It’s not difficult to imagine the consequences for borrowers when their interest rate jumps from less than 2% to more than 6%.
For some borrowers, the jump will be unsustainable.
It’s estimated that $370 billion worth of Australian housing loans will convert from fixed to variable during 2023. Inevitably, the accompanying rise in servicing costs will create widespread mortgage stress.
Some homeowners faced with a spike in their interest rate will look to reduce their outgoings by refinancing their debt at a lower interest rate with an alternative lender. There’s often scope to do that given the competitive market for home lending.
However, a large proportion of the loans moving from fixed to variable interest rates in 2023 will be owed by people who purchased homes at or near the top of the over-heated post-pandemic property market. They will have lost some or all of their equity, making it impossible for them to refinance. In other words, many of those worst affected by rising interest rates will be least able to do anything to ease their predicament.
The obvious danger is that some will be forced to sell their homes, thereby putting more downward pressure on house prices and leaving more people in negative equity. Potentially a vicious circle of distressed sellers driving house prices down leading to yet more distressed sellers.
The fate in 2023 of many recent home buyers will depend on a range of factors, the key ones being house prices, interest rates, and the rate of unemployment.
The outlook for house prices is not promising. As we head into Christmas, prices are in decline in most parts of Australia. CoreLogic’s ‘National home value index’ was down for the seventh month in a row in November.
Prices in the Australian capital cities fell 3.5% in the three months to the end of November. In Sydney, the drop was 4.4%, taking the total slump from the January peak to 11.4%. In Brisbane, where prices started falling later than in Sydney and Melbourne, there was a drop of 5.6% in just the last three months.
In some places the pace of decline has slowed. However, CoreLogic Head of Research Eliza Owen warns that “there is still a risk of the decline re-accelerating in the year ahead”.
Christopher Joye, writing in the Australian Financial Review, adopts a more bearish perspective – “The most constructive thing we can say is that house prices are falling incredibly quickly, albeit at a slightly slower pace than what was recorded a few months ago”.
In some areas the drop has already been severe. According to CoreLogic, over the last twelve months houses in Narrabeen on Sydney’s northern beaches, and in Surry Hills in inner Sydney, have plunged 26.8% and 25.4% respectively. Units in Sydney’s Centennial Park and Mona Vale are down more than 20%.
Falls of that magnitude make negative equity inevitable for many recent buyers.
It’s difficult to envisage a change in the direction of house prices until there is more certainty around interest rates. For the moment at least, the expectation in most quarters is that rates have further to rise.
In his media release last week, RBA governor Philip Lowe stated that “the Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course”. Ominously for homeowners, particularly new ones, the Board “remains resolute in its determination” to bring inflation back within the RBA’s target range of 2 to 3%. It’s currently around 7%.
It takes some time before RBA rate rises are felt by borrowers. According to the Commonwealth Bank of Australia, the country’s largest home lender, “from a cash flow perspective the impact is not felt for three months on average for a CBA customer”.
This means that the cashflow of CBA variable rate customers has yet to be affected by the RBA’s last three rate rises. It follows that the pain from those rises has not yet been fully factored into house prices.
Add that delay to the anticipated additional rate rises next year, plus the conversion of $370 billion of mortgages from fixed to variable, and a challenging picture emerges for the housing market.
It’s going to be a nervous Christmas for many recent home buyers.
Ross Stitt is a freelance writer with a PhD in political science. He is a New Zealander based in Sydney. His articles are part of our 'Understanding Australia' series.
32 Comments
Here's a useful summary of the absolute peaks across major Australasian cities...
Auckland - Nov 2021 - Down - 18.1%
Melbourne - Jan 2022 - Down - 7.8%
Sydney - Feb 2022 - Down - 11.4%
Brisbane - Jun 2022 - Down - 8.1%
This data confirms what we already knew. Auckland in November 2021. The worst of the worst.
Why did so many people borrow so much when interest rates were so low? They need to teach basic financial literacy at schools. What goes up will come down and what goes down will come up eventually. Where I live so many nice homes are suddenly on the market and they are not selling. I suspect some people are selling before the proverbial hits the fan.
Real question is why did the banks lend so much if they're in the business of lending, and assessing the risks that goes with it? Why did they drop their test rates below 6%? What happened to basic financial literacy?
Next you'll be blaming an obese toddler for poor diet choices.
True. But like a lot of things in life, you enter into a contract with someone to provide you a product/service, and they manage the risk for you for a profit. Not mortgage lending for some reason?
Do we now expect adults to oversee the work of qualified electricians to ensure it's free from risk? Maybe the insurance company will deny a claim if the house burns down because, as an adult, you should have known the electrician shouldn't wire up a 10amp rated appliance to the 30amp fuse.
I think house prices in some areas of New Zealand have the potential to drop a lot further than they already have simply because buyers do not have the financial ability to borrow enough to buy them and because Banks will not be willing to lend them that money as Banks are risk averse. Throw in rising everyday costs such as food and further OCR rises next year and you have a perfect storm. Sell now as the offers you get next year will be lower than the one you are not currently impressed with.
So sad, there are a lot of first home buyers and movers like myself who are forced to borrow relatively more than previous years just to get a roof over our heads in a practical location. If its not a practical location all the other costs rise more petrol, longer childcare hours etc. Were not idiots for borrowing lots we know that interest rates rise, but we don't have a choice, the alternative is renting a family home which is actually more of a drain on income then buying a house at low interest rates. If interest rates rise its just a hurdle to jump in the future, the alternative of forever renting is worse. And if you have a wife and kids you can't have flatmates to help out. I feel successive governments have let a lot of people down with the policies of the last 20 years, residential housing should not be viewed as a commodity to trade and extract profit from, sure a little is fine but the scale that this takes place at now is wrong evidenced by declining owner occupier rates, which by the way is not a choice most people are making, they're just shut out of the market. Not the world I was thinking I would grow up in, forever struggling and my parents don't get it because they're maths illiterate
In this 2 party transaction between the borrower and bank, it was the bank that took the lead on the risk assessment, therefore the bank should be held to account if their risk assessment results in sub-prime borrowers who have had no material change in their earnings.
Negative equity just is what it is, but to have interest rates nearly triple in a year? And somehow that's the recent FHB's fault.
It's too late now, but you should have first taken out a Finance Degree and paid that off before taking out the mortgage.
I agree the banks could have probably put a stop to this years ago by tightening credit, which they've shown they can do. But anyway I guess they're competing against each other in a race to the bottom (riskier and riskier home loans) to make a dollar. Now the banks should help those customers in a precarious place, the bank should now bear the monetary loss to keep the mortgage holder in their own home
Banks never make losses unless they have to such as a result of a mortgagee sale. Senior bank staff are on incentives and bonus schemes. They are the worst of of the worst. Even worse than real estate agents and car dealers. They love making money just like their employers.
Regularguy you have been screwed by boomers who could not buy enough rentals to satisfy their egos and greed. In saying that paying rent for a year or two longer could have saved you from borrowing hundreds of thousands in places such as Auckland and Wellington. As you said you knew interest rates were going to go up. Rent is not dead money. Paying interest to the Bank is a form of rent. If you had waited you would be borrowing a lot less and would not be losing equity.
Hindsight is 20/20 at the time you make decisions based on the information available, interest rates were down, for years they kept saying they would rise and never did, property values were rising and for years they said they would fall and never did, rent for a comparable home was significantly higher than what the mortgage would be, so what would a rational person choose, btw im not a seer so couldn't see the future.
Rent is also generally tied to wage inflation, that is rents will rise along with what wage earners can afford to pay. Mortgages you have the option of keeping payments same and enjoying pay rises, or increased payments against the principal amount.
Although it would be disastrous if we had a reverse of the last 30 years, where interest rates creep up in the duration of one's loan term and while the principal amount falls, the interest portion in dollar terms remains the same.
Depends on how much indebted Landlords can squeeze from tenants, so many gorged themselves on cheap debt, hence wailing and shrieks about the deductibility rules. But yes in the short term we would expect rents to be less than a mortgage.
- Rent $500 per week
- Increases 5% p.a.
- After 15 years = $615k
- After 30 years = $1.84m paid
- $500k Mortgage, $917 per week @ 8% on 30 year loan term,
- Increase payments 5% per year
- Total interest = $404k, Total Loan $500k = $904k. Paid off in 15 years.
- $3k rates, $4k insurance increased at 5% p.a. = $200k in 15 years, $500k in 30 years
I'm curious to know how much people actually end up paying to own a mortgage-free house based on averages.
People always talk about buying a house for x and selling for z and implying z-x = profit
But x is purchase price, x + interest payments over 15 years must be a whole different figure
(plus all the sundries like rates, maintenance).
NzDan can you crunch the numbers? *I'm awful at maths) But less say a $1 mill house, 200k deposit, average interest rate over the 15? years something like 5%? (plus rates and other such costs etc).
Cheers
$500k loan over 15 years at 5% = $211k in cumulative interest (on a loan with 15 year schedule payments). If you took out a $500k mortgage with 30 year scheduled payments, but increased your repayments by 10% every 12 months, you'd have the loan paid off in 12 years 3 months and have paid $209k in interest.
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