Mortgage Rates


So my 12 year old daughter asks, “Why is it that any time there is good news about the economy they also say that there is pressure on mortgage rates to rise? Why does the good news also average bad news?”

A fair question in my opinion. examine the headlines – “Jobless Numbers Down – Pressure on Mortgage Rates”, “Promised Tax Cuts may see increase in Mortgage Rates”, “Third subsequent Quarterly Economic Growth figures see Mortgage Rates set to Rise”. Then, of course, there are other factors totally out of our control which can also affect mortgage rates such as the recent global liquidity and credit crisis emanating from the US economy.

Mortgage rates are influenced by the official interest rate or Target Cash Rate as set by the save Bank. When the save Bank changes the official rate and in turn, mortgage rates, it is attempting to influence expenditure in the economy. When expenditure exceeds production, inflation results. consequently mortgage rates are used as a tool to control inflation as a part of monetary policy.

Higher mortgage rates affect borrowers’ cash flows and reduce the amount of money that consumers are able to use on goods. Lower mortgage rates have the opposite effect. And because lower mortgage rates average that people have more to use it puts pressure on prices due to increased need it puts further inflationary pressures on the economy.

In the dizzy days of the late 1980s inflation was rampant and mortgage rates peaked at 17% per annum. The high mortgage rates severely limited housing affordability. Since those days governments and the save Bank have tended to micro manage the economy to avoid major peaks and troughs. Small increases in mortgage rates, although politically unpopular, are an effective method of stabilising the economy. A little research into the history of mortgage rates in this country will show that, at current levels, they are nevertheless comparatively low.

It should be noted, however, that when we talk about mortgage rates we are generally referring to “moderate” mortgage rates (as nominated in loan contracts, advertising etc). Economists, however, talk in terms of “real” mortgage rates. So what is the difference between moderate and real mortgage rates? Real mortgage rates take into account the effect of inflation so that Real Mortgage Rates = moderate Mortgage Rates minus Inflation Rate.

In 1989 when the moderate mortgage rate was 17%, inflation was running at approximately 8% per annum. consequently the real mortgage rate would have been 9% per annum. Today moderate mortgage rates are approximately 8% per annum and inflation is running at around 2% per annum so that the real mortgage rates are 6% per annum.

In fact if we research real mortgage rates in Australia over the last 25 – 30 years we find that they have hovered within 2% per annum and 10% per annum, compared to moderate mortgage rates which have been between 6% per annum and 17% per annum over the same period. clearly it is much sexier for politicians to spruik about enormous reductions in moderate interest rates.

So in summary, to answer my daughter, an occasional little pain with mortgage rates may rule to a huge gain in the overall scheme of things.

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