Home Loan Affordability-May-2007
This monthly series is designed to measure how much of average weekly take-home pay is required to make a standard mortgage repayment for an average house.
As at the end of May 2007, the national average was 79.3%, up marginally from April 2007 (79.2%), but up much more dramatically from April 2006 (66.8%).
That is, it now takes at least 79.3% of the average take-home pay to afford a standard mortgage payment of a median-priced house, as at May 2007.
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In May 2002, five years ago, it took only 46.3% of take-home pay to make a mortgage payment on a median house. The index methodology is detailed below.
The drivers of the May 2007 increase were …- median house prices rising +0.3% since April 2007, +14.8% since May 2006,- benchmark interest rates crept up marginally from 8.784% in April 2007 and 7.879% in May 2006 to 8.794% in May 2007 as wholesale money cost pressures abated,
while take-home weekly pay estimates rose from $670.25 in April 2007 and $643.31 in May 2006 to $671.65 in May 2007.
Weekly take-home pay rose +$28.34 in the past twelve months, while weekly mortgage payments for a median-priced house has risen a whopping +$103.01. (This compares buying a median-priced house with average take-home pay between May 2006 and May 2007.)
There were no OCR increases in May. And, wholesale money costs rises were muted as these markets absorbed the April rises and international markets shifted sideways.
This index is designed to be a benchmark. Home buyers on average incomes may well choose to purchase a house below the median price level, and that will make their transaction more affordable. This survey does not yet have access to lower-quartile house price data.
But the changes in prices and interest rates reported here will be very similar no matter what band the home buyer is in. Home loans are getting less affordable for most people because house prices and interest rates are rising faster than take-home pay.
Full reports for each region are available online and include:
- Northland (154kb .pdf)- Auckland (154kb .pdf)- Waikato and Bay of Plenty (153kb .pdf)- Hawkes Bay and Gisborne (154kb .pdf)- Taranaki (154kb .pdf)- Manawatu and Wanganui (153kb .pdf)- Wellington (154kb .pdf)- Nelson and Marlborough (154kb .pdf)- Canterbury (153kb .pdf)- Central Otago Lakes (153kb .pdf)- Otago (154kb .pdf)- Southland (154kb .pdf)
But what happened in June?
One of the features of this survey is that it able to predict the impact of subsequent events.
Reserve Bank surprised many with yet another OCR rise of +0.25%, the third consecutive increase in their review cycle.
Although many analysts were surprised - and certainly many viewing New Zealand from the financial centers of the world were - it was not exactly a surprise to the economists of three of the four main banks here, each of whom predicted it correctly.
One consequence of these predictions has been the speed with which the New Zealand banks have implemented the rise into their floating mortgage rates - that happened within a day or so of the announcement.
And there was also a rapid reaction by the wholesale money markets - their ’surprise’ translated into a rise in the risk premium applied to their lending to New Zealand. Those same international markets have seen rising bond yields, with the benchmark US Treasury 10 year bond reaching over 5.25% The flow-on effect of all this has also increased the costs for New Zealand funding of fixed rate mortgages.
This means that in the first two weeks of June, interest rates for fixed-rate mortgages have risen sharply. The two year fixed rate is now 9.25% at many banks, and averages 9.18% when the discounters are included.
Higher mortgage rates will impact affordability, and if June house prices remain unchanged, May’s index of 79.3% will convert to at least 81.9% in June - that is, it will take 81.9% of one average take-home pay to afford the mortgage payments of a median priced house.
This would be the worst affordability has ever been, and there is no real sign the situation is about to be reversed.
Even if house prices stay unchanged, it would then take an incredible 16 years of current take-home pay increases to bring this index back to the point where 40% of one average income could afford a mediam priced house - (and that in turn assumes tax-rates will be indexed, something the politicians have been very reluctant to do).
We seem stuck with an affordability crisis for a very long time unless major public policy changes are made.
Urgent actions attacking housing supply inhibitors and new-build rates are required.
Sources / Definitions / Methodology:
Average gross weekly earnings are sourced from Statistics New Zealand’s quarterly series. For the latest months a factor is applied to estimate the most recent periods, and this makes the outcome for those months provisional. (The impact of this process on the overall affordability measures is considered very low.)
Average mortgage interest rates are sourced from www.interest.co.nz. These averages are for banks only, because banks have 90%+ of the mortgage market. Affordability calculations are done for mortgages using floating, and the five fixed-rate terms. For the purpose of the data in this Report, the two-year fixed mortgage interest rate is used. This is, and has been the most popular term. However, the market is shifting to longer term rates, and the index reviews allow for keeping track of affordability issues as this shift happens.
The tax adjustments to average gross weekly earnings are per the PAYE tables issued by the IRD. This converts gross earnings to take-home pay.
Median house prices are as reported by the Real Estate Institute of New Zealand. We are using the REINZ series because it is more timely. We have run a detailed correlation with the QV series, and while the REINZ series may be seen to be more volatile in the short run, and the ‘median’ definition theoretically problematic, in fact the two series track very similarly, with the REINZ series giving an earlier indication of market trends.
Average gross weekly earnings are a national measure only. However, Statistics New Zealand also publish regional earnings data annually, by regional council areas, and this data is used to modify the national data into regional equivalents.
Average savings interest rates are sourced from www.interest.co.nz. These averages are for banks only, and use the one-year term deposit rate. This interest is credited to the time needed to save for the deposit, after deducting the IRD’s resident withholding tax for interest at the gross income level of the saver.
The home loan is assumed to be for 80% of the median house price, with the remaining 20% as part of the time-to-save deposit index.
The home loan is assumed to be a standard table mortgage, where both interest and principal is repaid in a level standard weekly payment. The repayment is calculated using the tools at www.interest.co.nz/calculator. Interest in arrears is assumed.
The affordability index in this Report is calculated by dividing the weekly mortgage payment for a median house price into the weekly take-home pay. An index is generated for each region, and nationally, and for each of the mortgage interest rate terms.
Thursday, October 11, 2007
Don’t go for a fixed-rate home loan now
Don’t go for a fixed-rate home loan now
Fixed interest rates of home loans have swung from a low of 7 per cent in 2003 to 13.5 per cent now, and industry experts finally believe that they have peaked. Says Kapil Wadhawan, vice-chairman and MD of Dewan Housing Finance Corporation [Get Quote]: “If rates go up any further, it will begin to hurt customers and the entire economy will be impacted. The corporate sector will be pressured. A further hike in interest rates is not advisable.
“Though there is a lingering concern about inflation and high liquidity, and the Reserve Bank of India [Get Quote] might be forced to intervene and increase the CRR further, the rates should stabilise in the next six to eight months.” Some experts say that even if there is an increase in interest rates, it would be very marginal - not more than 50 basis points.
Why you should not go for fixed rates. If interest rates have peaked, as most indicators seem to suggest, then there is no point in opting for a fixed rate home loan. The irony is that most banks and housing companies are now trying to push home loans at fixed rate. “A fixed rate regime is a strong interest regime,” says Wadhawan. “Fixed rate should be preferred even if it seems high.”
However, Harsh Roongta, CEO of Apnaloan.com, roots for floating rates for home loans in the current scenario. He says there is no need to pay the 2 per cent premium that the fixed rate loan would entail. “Even if interest rates go up marginally, the impact on floating rates would still be less than 2 per cent,” he says.
Roongta is certain a new cycle of interest rates will begin. “Interest rates will go down and come up again. One cannot say when that will happen, but it is bound to happen,” he says.
Financial planner Zankhana Shah adds that whether floating is favourable or not, you should have the means to change to the fixed rate when the situation demands. This means that you should set aside cash to pay the penalty for switching over. “Or else, make sure to go for a floating rate with a lower tenure,” she says. “Also, it is difficult to predict beyond four to five years in the interest rate market, whereas home loans usually have a horizon of 15 years.”
Her advice is also that you should ideally wait till there is some clarity on the direction interest rates are likely to take. She says: “In our country, fixed is never fixed and floating is never floating. And so, it may just happen that your floating rate of interest on the home loan does not go down after an overall fall in interest rates.”
Roongta concurs with Shah on the practice in India regarding fixed and floating rate home loans. “Customers should be vigilant about the contracts they sign with banks,” he cautions. “Do not settle for a half-floating or a half-fixed rate loan. Most banks in our country do not offer a pure floating rate or a pure fixed rate. If the bank is denying you a pure fixed rate or a pure floating rate loan, then take up the issue with the concerned authorities.”
Do you need to switch over? The near unanimous view today is that interest rates are unlikely to go higher than their current levels, even when they rise again in the next cycle. By this token 14 per cent is likely to be the highest that housing loans would cost. If that is the case, then it is certainly not prudent to take a fixed rate home loan. If need be, you could even convert a high fixed rate loan to a floating rate one.
Shifting from fixed to floating rate makes sense only if the fixed rate is higher than the current floating rate (see Should You Convert From Fixed to Floating?)
What you need to do. It would be best to wait for clarity to emerge on the likely future of interest rates before taking a loan to buy a house. But if you want to buy right away, then opt for a lower tenure of the home loan. And if you must take a loan with a high tenure, then keep money aside to pay the penalty for switching back to fixed, in case the need for doing that arises.
Should You Convert From Fixed to Floating?
Don’t change to floating rate if you took a loan about four years back at a fixed rate that is below the current floating rate and, in case it is not a purely fixed rate loan, the bank has not yet revised the rate. “Decide after the rate changes to the current levels,” says Harsh Roongta.
Don’t switch over if you took a loan about a year back at a fixed rate that is close to the current floating rate. Rates have not yet been revised to current levels for loans that are not purely fixed.
Convert if you took a fixed rate loan recently at 13.5%, which is above the current floating rate levels. The total EMI for the floating rate plus the penalty for shifting (close to 1.75% of the outstanding amount) should not exceed the total EMI for the fixed rate loan. Weigh the tax benefits for both scenarios too.
Fixed interest rates of home loans have swung from a low of 7 per cent in 2003 to 13.5 per cent now, and industry experts finally believe that they have peaked. Says Kapil Wadhawan, vice-chairman and MD of Dewan Housing Finance Corporation [Get Quote]: “If rates go up any further, it will begin to hurt customers and the entire economy will be impacted. The corporate sector will be pressured. A further hike in interest rates is not advisable.
“Though there is a lingering concern about inflation and high liquidity, and the Reserve Bank of India [Get Quote] might be forced to intervene and increase the CRR further, the rates should stabilise in the next six to eight months.” Some experts say that even if there is an increase in interest rates, it would be very marginal - not more than 50 basis points.
Why you should not go for fixed rates. If interest rates have peaked, as most indicators seem to suggest, then there is no point in opting for a fixed rate home loan. The irony is that most banks and housing companies are now trying to push home loans at fixed rate. “A fixed rate regime is a strong interest regime,” says Wadhawan. “Fixed rate should be preferred even if it seems high.”
However, Harsh Roongta, CEO of Apnaloan.com, roots for floating rates for home loans in the current scenario. He says there is no need to pay the 2 per cent premium that the fixed rate loan would entail. “Even if interest rates go up marginally, the impact on floating rates would still be less than 2 per cent,” he says.
Roongta is certain a new cycle of interest rates will begin. “Interest rates will go down and come up again. One cannot say when that will happen, but it is bound to happen,” he says.
Financial planner Zankhana Shah adds that whether floating is favourable or not, you should have the means to change to the fixed rate when the situation demands. This means that you should set aside cash to pay the penalty for switching over. “Or else, make sure to go for a floating rate with a lower tenure,” she says. “Also, it is difficult to predict beyond four to five years in the interest rate market, whereas home loans usually have a horizon of 15 years.”
Her advice is also that you should ideally wait till there is some clarity on the direction interest rates are likely to take. She says: “In our country, fixed is never fixed and floating is never floating. And so, it may just happen that your floating rate of interest on the home loan does not go down after an overall fall in interest rates.”
Roongta concurs with Shah on the practice in India regarding fixed and floating rate home loans. “Customers should be vigilant about the contracts they sign with banks,” he cautions. “Do not settle for a half-floating or a half-fixed rate loan. Most banks in our country do not offer a pure floating rate or a pure fixed rate. If the bank is denying you a pure fixed rate or a pure floating rate loan, then take up the issue with the concerned authorities.”
Do you need to switch over? The near unanimous view today is that interest rates are unlikely to go higher than their current levels, even when they rise again in the next cycle. By this token 14 per cent is likely to be the highest that housing loans would cost. If that is the case, then it is certainly not prudent to take a fixed rate home loan. If need be, you could even convert a high fixed rate loan to a floating rate one.
Shifting from fixed to floating rate makes sense only if the fixed rate is higher than the current floating rate (see Should You Convert From Fixed to Floating?)
What you need to do. It would be best to wait for clarity to emerge on the likely future of interest rates before taking a loan to buy a house. But if you want to buy right away, then opt for a lower tenure of the home loan. And if you must take a loan with a high tenure, then keep money aside to pay the penalty for switching back to fixed, in case the need for doing that arises.
Should You Convert From Fixed to Floating?
Don’t change to floating rate if you took a loan about four years back at a fixed rate that is below the current floating rate and, in case it is not a purely fixed rate loan, the bank has not yet revised the rate. “Decide after the rate changes to the current levels,” says Harsh Roongta.
Don’t switch over if you took a loan about a year back at a fixed rate that is close to the current floating rate. Rates have not yet been revised to current levels for loans that are not purely fixed.
Convert if you took a fixed rate loan recently at 13.5%, which is above the current floating rate levels. The total EMI for the floating rate plus the penalty for shifting (close to 1.75% of the outstanding amount) should not exceed the total EMI for the fixed rate loan. Weigh the tax benefits for both scenarios too.
Home Mortgage-are You Paying Too Much?
Traditionally, when home buyers signed on for a mortgage, they had one option: A 30-year mortgage with a fixed interest rate. During the past decade, adjustable-rate loans rose (and fell). Now, with savvier home buyers who are more eager to pay off loans quickly, the 15-year mortgage has gained in popularity, especially for refinanced home loans.
Home mortgages come in all shapes and sizes, from loans with 40- or 50-year terms to seven-year refinance loans designed for homeowners with a small balance. Following recent scandals about suspect lending practices that have resulted in a rash of foreclosures, lenders are making it tougher to qualify for a mortgage. Find the best loan for your purposes by asking yourself:
What payment can you afford? The mortgage industry is cracking down on bad lending practices such as misuse of prepayment penalties, low-documentation loans that allow or encourage borrowers to borrow more than they can pay, mishandled escrow accounts and too-high debt-to-income ratios that put a borrower’s financial security at risk. But still be aware that you might be offered a mortgage with a higher payment than you are comfortable making. Choose a home loan amount with payments you believe are affordable, whatever the term.
How long will you own the home? If you are sure you will stay in the home for only a few years, the loan term may matter less. Choose the product with the best up-front terms. On the other hand, if you intend to keep the home for many years, decide whether you prefer somewhat higher payments knowing the loan’s end is relatively near, or easier payments that go on for a longer period. Also consider your family’s life stage. If a 15-year loan would mean mortgage payments would end just as your firstborn heads to college, the timing might make a shorter loan worthwhile.
How important to you is total interest paid? On a home loan of $160,000, a 30-year mortgage at 7 percent annual interest would result in more than $223,000 in interest payments over the life of the loan. In contrast, a 15-year mortgage at the same rate costs less than $99,000 in interest! Clearly, the savings in interest and in time makes shorter home loans appealing to many borrowers. But if you choose the longer-term loan, take heart — the additional interest you pay is tax deductible.
How disciplined are you? Many people argue that a 15-year mortgage and a 30-year mortgage can be made essentially the same. They believe homeowners should obtain a 30-year mortgage and then make extra principal payments every month. For a mortgage amortized over 30 years, making one extra principal and interest payment per year will pay off the loan eight years sooner. (Divide one principal and interest payment by 12, and add that amount to the monthly mortgage payment to total one extra payment over the course of the year.) If you hope to pay your mortgage off early, do you have the discipline to stick with your payment plan?
How much flexibility do you need? An advantage to a longer-term loan is that the payments are lower. On the same loan mentioned in #3 — used to purchase a $200,000 home with 20 percent down — the payment on a 30-year mortgage is $375 less per month than the payment for a 15-year loan. Even if you can afford the shorter loan, choosing a 30-year term and paying an additional $375 principal each month leaves the option of using that money elsewhere if it’s needed in an emergency. Whichever you choose, it is a good idea to be sure the loan has no penalty for prepayment (paying the loan off early).
Do you have other debt you should pay off first? All things considered, a mortgage is relatively “good” debt. With every payment, you invest in your future. For most people, the interest is tax-deductible. And current home loan interest rates are fairly low. If you’re like millions of Americans who owe thousands on credit cards — with interest rates up to 20 percent or higher — you would be wise to apply extra cash to paying off credit card debt before you focus on making additional payments on your mortgage loan.
Home borrowing has no one-size-fits-all solution. For the best outcome, take a clear view of your situation before selecting a mortgage product. Then be sure that whatever you choose, you make payments on time — and enjoy your new home.
Home mortgages come in all shapes and sizes, from loans with 40- or 50-year terms to seven-year refinance loans designed for homeowners with a small balance. Following recent scandals about suspect lending practices that have resulted in a rash of foreclosures, lenders are making it tougher to qualify for a mortgage. Find the best loan for your purposes by asking yourself:
What payment can you afford? The mortgage industry is cracking down on bad lending practices such as misuse of prepayment penalties, low-documentation loans that allow or encourage borrowers to borrow more than they can pay, mishandled escrow accounts and too-high debt-to-income ratios that put a borrower’s financial security at risk. But still be aware that you might be offered a mortgage with a higher payment than you are comfortable making. Choose a home loan amount with payments you believe are affordable, whatever the term.
How long will you own the home? If you are sure you will stay in the home for only a few years, the loan term may matter less. Choose the product with the best up-front terms. On the other hand, if you intend to keep the home for many years, decide whether you prefer somewhat higher payments knowing the loan’s end is relatively near, or easier payments that go on for a longer period. Also consider your family’s life stage. If a 15-year loan would mean mortgage payments would end just as your firstborn heads to college, the timing might make a shorter loan worthwhile.
How important to you is total interest paid? On a home loan of $160,000, a 30-year mortgage at 7 percent annual interest would result in more than $223,000 in interest payments over the life of the loan. In contrast, a 15-year mortgage at the same rate costs less than $99,000 in interest! Clearly, the savings in interest and in time makes shorter home loans appealing to many borrowers. But if you choose the longer-term loan, take heart — the additional interest you pay is tax deductible.
How disciplined are you? Many people argue that a 15-year mortgage and a 30-year mortgage can be made essentially the same. They believe homeowners should obtain a 30-year mortgage and then make extra principal payments every month. For a mortgage amortized over 30 years, making one extra principal and interest payment per year will pay off the loan eight years sooner. (Divide one principal and interest payment by 12, and add that amount to the monthly mortgage payment to total one extra payment over the course of the year.) If you hope to pay your mortgage off early, do you have the discipline to stick with your payment plan?
How much flexibility do you need? An advantage to a longer-term loan is that the payments are lower. On the same loan mentioned in #3 — used to purchase a $200,000 home with 20 percent down — the payment on a 30-year mortgage is $375 less per month than the payment for a 15-year loan. Even if you can afford the shorter loan, choosing a 30-year term and paying an additional $375 principal each month leaves the option of using that money elsewhere if it’s needed in an emergency. Whichever you choose, it is a good idea to be sure the loan has no penalty for prepayment (paying the loan off early).
Do you have other debt you should pay off first? All things considered, a mortgage is relatively “good” debt. With every payment, you invest in your future. For most people, the interest is tax-deductible. And current home loan interest rates are fairly low. If you’re like millions of Americans who owe thousands on credit cards — with interest rates up to 20 percent or higher — you would be wise to apply extra cash to paying off credit card debt before you focus on making additional payments on your mortgage loan.
Home borrowing has no one-size-fits-all solution. For the best outcome, take a clear view of your situation before selecting a mortgage product. Then be sure that whatever you choose, you make payments on time — and enjoy your new home.
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