41.4% of income needed to service mortgage, finds report

More than two-fifths of a borrower’s income is needed to service a new mortgage, according to new research.

The findings came in the latest ANZ CoreLogic Housing Affordability Report, which has found that the rapid rise in house prices and rental costs has led to a deterioration in housing affordability.

As the Australian economy recovers from the COVID-19 pandemic with strong increases in employment and inflation, the report sought to understand housing affordability across each of Australia’s housing markets in the March 2022 quarter by measuring affordability through four factors:

• The ratio of dwelling values to household income
• The number of years taken to save a 20 per cent deposit (the proportion generally needed to access a mortgage without paying lenders mortgage insurance)
• The portion of income required to service a new mortgage
• The portion of household income required to service rent

The report has revealed that affordability had worsened for both home owners and renters, with new records being set over the period to March 2022 for both time to save a deposit and value-to-income ratios.

As well as this, the research found that the portion of income required to service mortgages had increased for the third consecutive quarter.

By looking at mortgage serviceability for median income households servicing a mortgage if they were to purchase in the March quarter of 2022 (assuming a loan-to-value ratio of 80 per cent and paying the average discounted variable mortgage rate at that time for a term of 25 years), the ANZ and CoreLogic researchers found that borrowers would need to use 41.4 per cent of their gross annual household income to meet new mortgage repayments.

This figure was above the decade average of 36.52 per cent and marked the third consecutive increase at the national level.

The report noted that higher average mortgage rates and property values were contributing to the overall uplift.

While affordability metrics on mortgage serviceability have remained below record highs seen in 2008 (during the global financial crisis) – and are below more recent highs in 2010 – this could partly be due to the record-low cash rate environment at the time, which had “tempered interest costs, even at record price levels,” the researchers stated.

The proportion required to service a new mortgage in the combined capital cities was 40.9 per cent while it was 38.3 per cent in the regions, where property prices are lower than in the capitals (but have been increasing rapidly).

However, the research also found that there were around 100 regions where it was still cheaper to service a new mortgage than rent in March 2022.

For example, Katherine in the Northern Territory requires just 22.5 per cent of income to service a new mortgage, but 38.0 per cent is needed to pay rent. Over in Western Australia, the Goldfields region only requires borrowers to set aside 12 per cent of their income to service a mortgage, but 22.7 per cent of it is needed to rent there.

Rising rate environment and falling prices putting pressure on affordability

However, given that variable mortgage rates have now started increasing off the back of the official cash rate lifting, the report has said there could be additional challenges around housing affordability.

For example, ANZ expects the cash rate to rise to 2.25 per cent by May 2023, but housing values are expected to decline as interest costs rise. 

While this drop in prices could lower the deposit hurdle, in a higher interest rate environment, mortgage serviceability may “become more challenging, even as price levels (and therefore deposit hurdles), decline,” the ANZ CoreLogic Housing Affordability Report outlined.

The research – spearheaded by CoreLogic head of Australian research Eliza Owen and ANZ’s senior economist Felicity Emmett – outlined different potential implications of higher rates for mortgage servicing, assuming an increase to average mortgage rates of 2.25 percentage points and various levels of nominal decline in housing values.

It found that should lenders pass on the 2.25-percentage point rise in the average mortgage rate, mortgage repayments will be higher in almost all scenarios. For example, if the price of the median Australian dwelling ($738,975) dropped by 10 per cent and variable rates rose to 4.72 per cent, monthly repayments would be $439 more a month.

The only exception would be if property prices drop by 25 per cent or more. 

The report read: “[T]he most expensive dwelling markets see substantially higher serviceability costs on new mortgages, even as prices decline, when interest rates rise. For example, in Sydney’s Northern Beaches, monthly mortgage repayments would be $970 higher if prices were to fall 15 per cent, and mortgage rates saw a full 2.25 per cent rise.”

(However, the analysts conceded that mortgage repayments in these scenarios are not static over the life of the loan, and the interest rate cycle could drive interest costs higher or lower over time).

Even borrowers taking advantage of government support such as the guarantee schemes (are able to take on a mortgage with as little as a 5 per cent deposit without having to pay lenders mortgage insurance [LMI]) would face affordability constraints, as they would be under higher mortgage repayments under the higher interest rate scenario.

The researchers noted: “Actual future scenarios may be very different in terms of the eventual peak in mortgage rates (with financial markets currently pricing in a lift in the cash rate to peak closer to 3.25 per cent), and the ultimate decline in housing prices. But weighing up higher interest costs with lower prices should be a key consideration for first homebuyers.”

Speaking to Mortgage Business about the report, ANZ’s general manager of home loans, John Campbell, said that only time would tell if there will be a “happy medium” for borrowers regarding rates rising and values dropping, however he added that lenders may also become more aggressive on pricing as borrowers look to refinance.

“I think competition is one thing that we have to put into the mix,” he told Mortgage Business.

“I think you will see in the months ahead, as the interest rate environment evolves and changes, that the competition amongst banks is very likely to continue to increase. It is already quite an intense competition but I think we’ll find that it continues.

“So, that will play into the favour of consumers, as lenders will be keen to have new business from people refinancing across, or from new home owners coming onto the book looking to get a good, competitive price. So, I think you’ll start to see that putting downward pressure on rates and, to some extent, offsetting what we’ve been seeing with the cash rate increasing.”

[Related: Time taken to save a deposit hits record 11.4 years]