Home Interest rate Interest rate hikes hurt more than before because the real estate game has changed

Interest rate hikes hurt more than before because the real estate game has changed

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For a given mortgage rate, the share of income absorbed by mortgage payments is much, much higher.Credit:Peter Rae

If you have a small loan with a high rate, all you need is lower rates, some inflation and decent income growth, and your mortgage load can drop sharply.

That was how it was for borrowers in the 1990s. High rates stung, but not for long.

Borrowers in the 1990s who started spending more than 30% of their income on paying off a mortgage found themselves spending only 12% halfway through the loan.

For borrowers in the 1990s, high rates stung, but not for long.

For borrowers in the 1990s, high rates stung, but not for long.Credit:Peter Rae

It’s different if you’ve borrowed recently.

If you’ve taken out a big loan at today’s ultra-low interest rates, there’s only one way to make your mortgage payments – and that’s up.

Even if mortgage rates stabilize at around 5% – which is implied by some of the Reserve Bank Governor’s statements – and wages rise faster than they have in a decade, Mortgage charges for millennials who bought homes recently won’t decline much.

The extraordinary increase in house prices and debt means that mortgage rates of 7% would be as painful for borrowers today as rates of 17% were decades ago.

It’s a common barb that newer generations struggle to access home ownership and housing costs due to overspending, crushed lawyers, and the like.

But millennials are spending less of their income on “discretionary” items – such as alcohol, clothing and household services – than people of the same age decades ago.

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What millennials spend a lot more on is housing, simply because houses are so much more expensive.

So, as the Reserve Bank continues to raise rates, it’s important to keep in mind that comparisons between yesterday and today miss the whole story.

Soaring real estate prices have changed the situation. For millennials, even historically low increases in interest rates will hurt.

Joey Moloney is a senior associate at the Grattan Institute. Brendan Coates is Program Director, Economic Policy at the Grattan Institute.

This article originally appeared in The Conversation.