So, I’m making a call on interest rates.  It’s such a common thing for me to hear from people that they, or more likely their parents, are worried that home loan interest rates are going to go back to 18% one day.  If this were to happen, how are they going to be able to afford their home loan repayments?  I have a simple answer for them:

Relax a little

If that doesn’t work, grab a bottle of wine, pour out a nip – check it’s good, now drink the bottle.  Rates are not going to go to 18%, at least, not any time soon.  How can I be so sure?  It’s as simple as analysing the numbers.  Back in 1989, Australian interest rates peaked at an all time high of 17.00% and stayed there for almost 12 months.  In fact, from June 1988 until May 1991, raters were consistantly above 14%.  So, how would the average Australian cope with 14% or higher interest rates?  In simple terms, very badly.  But it’s not something we’re going to have to worry about.

So, I’ve said it a few times that we’re not going to have to worry about 17% home loan interest rates, need me to prove it? Easy.  There are some very simple stats that you need to be aware of.  The main one is around how much of our income we’re spending on servicing our debt.  The cost of debt is minimum loan repayment which is a direct result of the interest rate that we’re being charged.  Back in 1989, we were paying about 9.5% of our income (nationally) towards the interest on our debt. In 2008, this reached an all time high of 12% and has since fallen back to around 7.2%.  What this means is that in the current environment, we’re paying almost as much of our income towards debt as we were when rates were at 17%.  If rates were to DOUBLE from 4.5% to 9%, then we’d be paying back an unprecedented 14.4% of our income to servicing interest.  If rates were to quadruple to 18%, then 28.8% our incomes would be going towards paying off interest.  This would not leave sufficient to run the economy and Australia as we know it, would come to a complete standstill.  Increasing rates is supposed to slow the economy down, not bring it to its knees.

Why are the numbers so different now?  Quite simply, we have more debt now than at any point in time, in real terms (ie, adjusted for inflation).  Again, back in 1989, the average amount of debt as a percentage of household income was around 65-70%.  Today, it’s at 180% – so that’s almost three times higher.  What that means is that every time rates go up, it has three times the effect than what it did before.  Just look at the numbers.  If you had $100 in debt and rates went up by 1%, you’d be paying $1 more in interest.  If that debt were $300, a 1% increase in rates would now be $3 extra, so there is no need to raise rates as high as they used to in order to slow the economy down by the same amount.  There is a much longer way to explain this, however I think you’re getting the idea by now.  Post a comment if you want the longer version!

So how high can home loan interest rates go in the current economic environment?  I’ve got no idea, that realy is a crystal ball question.  But I do know know that in the foreseeable future, they’re most definately not going up to 18%

Happy hunting everyone!