Expensive houses to be hit worst, borrowing capacity to fall

What the RBA sees ahead for real estate

Expensive houses to be hit worst, borrowing capacity to fall

Expensive homes will take the biggest hit from interest rate rises, according to a top Reserve Bank official.

In a Monday speech at the AFR Property Summit, RBA head of domestic markets Jonathan Kearns outlined the effects the central bank’s rate rises could have on the property market.

Kearns said that some of his colleagues at the RBA had studied the effect of interest rate hikes on property prices and found that rate hikes could have different effects on different types of housing. The effect of the hikes could also vary regionally.

“They found evidence that, controlling for other factors, interest rates can have larger effects on housing prices in locations where the supply of housing is less flexible, mortgage debt is higher, there are more investors and incomes are higher,” he said. “These estimates do not indicate that these factors cause housing prices to be more responsive to changes in interest rates, but they do highlight that the sensitivity of housing prices to interest rates is not going to be uniform across the country.

“What’s more, they find that housing prices in the most expensive areas are the most sensitive to interest rate changes,” he said. “This matches the observation that housing prices in more expensive locations are more cyclical. Similarly, there is some evidence that detached houses are more sensitive to changes in interest rates than apartments.”

Kearns said that detached houses’ greater sensitivity to rate changes could be partly explained by the limited supply of available zoned land.

“Overall, this indicates that an increase in interest rates narrows the distribution of housing wealth, since more expensive properties experience a larger fall in prices,” he said. “But their results suggest that this distributional effect is temporary, as the effects of interest rates on more expensive and cheaper properties converge over time.”

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Kearns also highlighted the impact of rate hikes on borrowing capacity.

“A lot of media attention is placed on the increase in existing borrowers’ repayments when interest rates increase – but higher interest rates also reduce the maximum loan size for prospective borrowers looking to purchase housing,” he said.

A year ago, the Australian Prudential Regulation Authority increased the minimum serviceability assessment rate that banks must use to determine maximum loan size. Banks must now assess borrowers’ ability to pay using a rate at least three percentage points above the loan’s interest rate.

“The increase in the cash rate since May has been 225 basis points, and so this has had a much larger impact on the maximum loan size than APRA’s requirement,” Kearns said. “Given this 225-basis-point increase in the cash rate has been fully passed through to mortgage interest rates, it will have reduced borrowers’ maximum loan size by around 20%. And because the assessment rate also applies to any existing debt, the decrease in borrowing capacity is even larger for borrowers who have existing debt, such as property investors.”