Rising interest rates will outweigh house price falls: Moody’s

An analysis from Moody’s Investors Service has warned declining property prices and improving wages will not be enough to improve housing affordability.

With inflation still rocketing, the Reserve Bank of Australia (RBA) has signalled that it will take further steps in the coming months to normalise monetary policy, after its 25-bp and 50-bp increases over May and June.

The interest rate changes will weigh on the housing market, Moody’s noted, with house prices expected to keep sliding over the rest of the year and into 2023.

House prices across Australia slipped by 0.1 per cent over May.

“However, based on our assessment of different housing price and interest rate scenarios, we expect that housing prices will not decline to the extent affordability improves while interest rates are rising this year,” the note from analyst Si Chen and associate managing director Ilya Serov stated.

“If the RBA raises the cash rate to 2.85 per cent this year, our modelling shows housing affordability will continue to worsen unless housing prices decline by around 22 per cent, a materially bigger decline than we currently expect by the end of the year.”

However, such a large price fall is not expected to take place.

In May, Moody’s tracked the average amount of monthly income that Australian households with two earners needed to meet their monthly repayments for new mortgages as 26.8 per cent, compared to 25.7 per cent in January.

If the RBA raises the cash rate by 2 percentage points from its current 0.85 per cent and house prices decline by around 10 per cent, the modelling from Moody’s has forecast that the average income borrowers would need to use to meet repayments would step up to around 31 per cent.

The measure of housing affordability had deteriorated across all Australian capital cities from four months earlier, and was worse for houses than apartments.

In Sydney, the least affordable city, new borrowers needed 37 per cent of household income to meet mortgage repayments, in contrast to 29.8 per cent in Melbourne, 23.1 per cent in Brisbane, 23.1 per cent in Adelaide and 16.3 per cent in Perth.

With the exception of Perth, the share of income borrowers needed to meet repayments on new mortgages was worse in May than the respective 10-year average for each city.

Zooming in on houses, buyers needed to use 30.2 per cent of their income to meet mortgage repayments in May, compared to 21.4 per cent for apartments.

The disparity between houses and apartments was most obvious in Sydney, where house buyers needed 47.1 per cent of their income to meet mortgage repayments in May, compared to 26.6 per cent for apartments.

Moody’s has forecast that the share of income needed to meet repayments will keep rising over the rest of the year.

Incomes are expected to pick up as the minimum wage has been increased by 5.2 per cent, the economy has stayed strong and unemployment is at record low levels, but not by enough to improve housing affordability.

Rising rates remain king, the note cautioned.

“Although household incomes are increasing, the rising interest rate environment will constrain homebuyers’ borrowing capacity,” the note said.

“In May, two large banks lowered maximum debt-to-income (DTI) lending limits for mortgage borrowers after [APRA] increased scrutiny of high DTI lending.”

ANZ and NAB both recently lowered their DTI ratios. NAB lowered its limit from a debt nine times greater than income to eight times, while ANZ made a more severe cut, from nine times to 7.5 times.

Moody’s noted that a DTI limit of 7.5 times would probably restrict most buyers in Sydney, as they would only be able to access a loan for around $1 million to $1.1 million.

“Our modelling shows that, at a maximum DTI of 7.5 times, the maximum borrowing capacity of an average income household in Sydney is below that of the average-priced house in the city,” the note stated.

Economists from ANZ have also predicted that the faster-than-expected rate rises from the RBA will accelerate the decline in house prices, forecasting a fall around 15 per cent over the next 18 months.

[Related: RBA’s fast rate rises to accelerate housing decline: ANZ]