Houses Are More Affordable Today, But Interest Rate in Buying Is Riskier

It seems people are feeling scared by rising home values. But the truth is houses are fairly more affordable now compared to the 1990s. I personally remember paying 18% interest on my mortgage! What the major risk for first time homebuyers nowadays is future rising interest rates.
 
Median measure, which is the ratio of media house prices to median salary, is used as a measure of affordability. The latest demographics survey shows that the median house price in Sydney is 12.2 times the median salary, while in Melbourne it is 9.5.  
 
However, these median measures are not reliable because it fails to consider the differences in interest rates in different time periods.
 
A property in 2017 with a price tag that is nine times the median salary, with mortgage interest rates below 4%, is cheaper than a property in 1990 priced at six times the median salary, with interest rates at 17%.
 
But the lower interest rates mean the present first-time home buyers are more at risk compared to their grandparents or parents decades ago.
 
Interest-rate risk
The possible effect that a slight increase in mortgage interest rates can have on the standard of living of homeowners is what is called interest-rate risk. This doesn’t take into account the possible path of interest rates, but how a 1% variation in interest rates impacts monthly amortisation required on a variable rate mortgage.
 
When interest increases, mortgage repayments follow. But when interest rates are lower, the proportionate increase is higher.
 
Using the example used previously, a home buyer in the 1990 has a much lower interest rate risk compared to a 2017 buyer. If interest increases by 1% in 1990, the increase in repayments would only be 5.7% to $2.923. Meanwhile, for the 2017 buyer, a rise of interest by 1% would result in repayments increasing by more than 12% to $5,368 per month.
 
This could potentially financially harm first-time home buyers, and because of the over dependence of the retail banking sector on residential property markets, possibly bring about a systemic financial disaster.
 
In summary
The general trend of interest rates compounds this situation.
 
Mortgage interest rates were at a record high in the 1990s and first-time home buyers could look forward to a decrease in their repayments in the coming years. But interest rates in 2017 are at record lows, so home buyers cannot and should not expect repayments to decline in the coming years.
 
So while today’s homes are more affordable than homes in the past, the interest rate risk is substantially higher and the forecast for returns on their investment is much more. If you’re a buyer planning to purchase your first home, it is smart to address the issues rather than exploit unreasonable median-based measures of property affordability.

Aside from resolving the problems related to housing supply, the government should also look into ways to minimise interest rate risk over the long term.

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