Interest rates: RBA and bank policy problems, and how to fix it.

Interest rates rises concerns for Australian home buyers and homeowners need to be addressed by the RBA and the Government

There is evidence that any mortgage rate increase will lead to mortgage stress for a lot of homeowners who has overcommitted of mortgage finance, either recently, or by buying at the top of the real estate market.

No interest rate in October will give mortgage relief

Firstly let me say that I don’t believe that interest rates will rise in October. I have previously said February 2010 was the next move up, but I am now thinking later this year might be the time that the Reserve Bank of Australia might move rates up by 0.25 percent interest up.

Interest Rate rise are inevitable

Australia is facing a high growth future and that means inflation will soon be an issue, so expect several interest rate rises in 2011.

Interest rates are a proven way to control consumer spending and inflation, and have put the dampener on house prices.

So new home buyers can’ have it both ways. Home buyers can buy home for less, and interest rates are not yet at the level they were before the Global financial crisis. On the other hand the problem is not entirely the home buyers fault.

Why the mortgage system in broken and needs fixing.

Saying the system of home loan lending in Australia is broken is probably going too far. Its not, and works well. But interest rate rises are a sledge hammer approach when a pin prick in one area is all that is sometimes required. For instance when the RBA is concerned about house prices, and interest rate rise will also impact on business lending rates and people who rent.

So interest rates are a blanket approach and can have victims that get no benefit.

The RBA’s keeping it simple approach is a good idea and interest rates and a floating dollar does a lot of the heavy lifting in keeping Australia a low inflation zone.

Right now the problem is not inflationary house prices.

Right now the problem is not house prices affecting inflation, but the rise and rise of mining as the main action in our economy. Miners will be investing big and that will have inflationary pressures in the economy.

The problem for home buyers and homeowners.

The problem that interest rate rises causes for first home buyers and homeowners alike is more of their wallet will go to mortgage repayments. Whilst this has always been the case, the issue now is that the banks have relaxed lending standards to the extent that home buyers now allocate double their incomes to the mortgage size as they did even ten years ago.

So a slight increase in interest rates have a much bigger affect on mortgage belt families than they did ten years ago.

The problem has been caused by looser lending practices

The break away has been the banks lending patterns, away from the traditional 30% of gross income, to approaching 50% of gross income, and this is where the problems of inters rates bites. A little bit of change knocks a lot of buyers out of the market and hurts a lot of homebuyers who bought at the top of the market.

This has created too many buyers and driving housing prices too high and lenders have allowed a doubling of income to loan ratios over the last ten years, as well as reducing deposit ratios.

The result is that mortgage is taking too bigger share of the homeowners wallet.

So tiny increases in mortgage repayments hurt homeowners and deter home buyers.

The fix

Banks need to be better controlled on lending to income ratios. Making more money available to more people has cause the housing inflation in the first place.

Building more modestly specified homes for low income earners, empty nesters and first homebuyers is another way to relieve mortgage stress.

Bigger saved deposits. By ensuring that home buyers have a decent deposit saved, it will increase savings, and reduce demand on housing and moderate prices. This is what happened during the the early days of the GFC, and has been recently relaxed.

Interest rates give the RBA a simple mechanism to control demand and therefore inflation for the good of all Australians. By better controlling bank lending to home buyers and particularly first home buyers, the mortgage stress felt by homeowners will be reduced and house values moderated.

Author: Rick Adlam, Mr Mortgage