Housing affordability is a hot topic for politicians & journalists at the moment. Property price rises of 75% in the last 5 years in Sydney and a similar amount in Melbourne have made it more difficult to save for a deposit, but at the same time interest rates are at historic lows which lowers monthly repayments.
There are winners and losers from property price rises, so all the talk from politicians about the housing affordability crisis doesn’t necessarily mean anything meaningful will be done.
Chart 1: Percentage of first home buyers in market
This has more than halved from 20% of the marker in 2012 to less than 10% of the market in 2017, at the same time property prices have increased 75% in Sydney / Melbourne and interest rates have fallen to all time lows. This means that the other 90% of property sales in Australia are going to people who already own a property or investors.
How do we define “affordability”?
That is a stupid question, surely higher property prices = less affordable.
Yes, but affordability must also take in to account wages and interest rates.
Chart 2: Housing Prices to Income Ratio and Mortgage Rates
House to income ratios are at all time highs, but interest rates are at all time lows.
Housing affordability refers to how long it will take you to save for a deposit which will depend on your current wages, and how much of your income will be used to make mortgage repayments.
Affordability also depends on where you live, and averages can be very deceptive. The average prices of property in any city also hide that many young people who dominate the first home buyer market would like to purchase closer to the city where there are abundant jobs and services. Some commentators say that young people are just too picky about where they live, but moving to outer areas where housing is cheaper increases the cost of transport, increases travel times and potentially moves people away from friends and family.
1) Saving for a Deposit
Unless you pay Lenders Mortgage Insurance (LMI), you will require a 20% deposit to purchase a property. Assuming your only source of deposit is savings from your wages (i.e. no inheritance or gifts from family members), the fastest you can save for a deposit assuming that you are a couple with no children on average wages:
- Couple with no children
- No other debt or credit cards
- Both earning the average annual salary of $80,740
- Only spend money on the bare necessities of rent, food, clothing and essential bills (i.e. no holidays or eating avocado toast out at cafes)
- Purchasing a $1m property, i.e. deposit of $200,000
- Time to save = (Deposit + Stamp Duty) / Annual Savings
- Where, Annual Savings = After tax income less basic cost of living
- Annual Savings = 61,308 * 2 – 41,779 = $80,837 / year
- Deposit + Stamp Duty / Annual Savings = 200,000 + 40,767 / 80,837 = 2.97 years
This is a bit unrealistic as not many people would be able to live this frugally, as it does not take account of any unexpected expenses, loss of job, illness, having children or property price rises in the 3 years.
2) Monthly Mortgage Payments
Mortgage payments are calculated based on current interest rates and property prices. In our example above, the couple purchased a $1m property, with a 20% deposit, therefore they would
- Mortgage Payment
- $1m property with, 20% deposit = $800,000 loan
- 4% interest rate
- 30 year loan term
- Principal & Interest Repayments
- Mortgage Payment = $3,819 / month
- Our Couple
- Annual basic cost of living, reduced by the amount of rent, and increase for rates, repairs and other costs of home ownership
- New cost of living = $25,337 for our frugal couple
- New Cash surplus (or availability for savings) = After tax income less basic cost of living less mortgage payment
- Cash Surplus = 61,308 * 2 – 25,337 – 3,819 * 12 = $51,151 / year
- On another measure, they were spending 3,819*12 / 80,740 *2 = 28.38% of their gross income on mortgage repayments
However, just because interest rates are currently low doesn’t mean they will always be. You can fix the rate on your mortgage, but unlike in other countries such as the US where you can fix the rate on your mortgage for the full 30 year term of your loan, you can generally only fix your rate for a maximum of 5 years in Australia. For this reason banks use a higher rate of interest when assessing owners ability to repay a mortgage. If rates were to increase to 7.25% (which is the rate banks use to assess afordability), monthly mortgage payments would increase to $5,457 and annual surplus decrease to $31,494
How does this compare to 5 years ago
- Saving for a deposit
- Our $1m property in Sydney would have cost $571,000 (assuming 75% price increase)
- Deposit + Stamp Duty = $114,285 + $21,462 = $135,747
- Time to save for deposit = 135,747 / (59,128*2 – 37,843) = 1.68
- A you can see, it would only take 1.68 years, or nearly half the amount of time to save for a deposit as it does in 2017
- Mortgage Payments
- Rates were at about 5.5% in 2012, making our mortgage payment $2,484
- New Cash Surplus = 59,128 * 2 – 22,950 – 2,484 * 12 = $65,498 / year
- In other words 2,484*12 / 77,840 * 2 = 19.14% of gross income on mortgage repayments. This is significantly less than the 28.84% of gross income that needs to be spent on mortgage repayments in 2017
Winners & Losers Of Property Price Increases
- First Home Buyers
- Clear losers, it takes longer to save for a deposit and a higher percentage of gross income to service the mortgage
- Already own one property that you live in with a mortgage
- Winners. Lower interest rates have decreased mortgage payments and price increases have increased wealth.
- People looking to trade up to a more expensive property
- Mixed. Price increases have increased equity in their property, and lower interest rates make repayments lower. However on an upgrade their loan size will have increased by more than if property prices had remained constant.
- Own one property you live in, plus one or more investment properties all with mortgages
- Big Winners. Lower interest rates have decreased mortgage payments and price increases have increased wealth
- Own property outright (no mortgage)
- Winner. Price increases have increased wealth
- Renter, not planning on purchasing
- Unchanged assuming rents have not increased above wage increases. However some people in this category may have previously planned on buying.
As can be seen most people have benefited from increases nearly everyone in the Australia has benefited from price increases combined with rate decreases.
Who wants property to become more affordable?
Chart 4: Most Important Issues Facing NSW
A recent survey shows that nearly half of all NSW residents think that property prices are the most important problem facing NSW.
Things that could (but wont) be done
As with all assets, prices are determined by supply and demand. Absent a market correction/crash caused by a major economic shock combined with increased unemployment or raised interest rates the only way to make property more affordable is to affect Supply / Demand:
- Reduce Demand
- Reduce immigration
- Remove incentives for investors, such as negative gearing
- Crack down on foreign investors
- Increase Supply
- Increase density in the areas people want to live
- Build more properties
- Make it easier for elderly people to downsize
Summing it all up
Housing has become significantly less affordable over the last 5 years, but despite survey respondents naming it one of the biggest problems facing us at the moment and talk from politicians about solving the crisis, the truth is that most people are actually better off. First home buyers make up a tiny percentage of the market and most people already own property. Any political action to put downward pressure on prices would be political suicide.
The only way for property to become more affordable is through natural supply/demand dynamics. But be careful what you wish for, as any major decrease in property would likely be caused by increased interest rates and/or increasing unemployment and that would likely make obtaining a mortgage much more difficult for first home buyers.