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Saturday, November 2, 2013

"Bubble Truths" and "anxiety about overpriced housing is overblown"

An article from the mainstream media brought interesting insight into a "bubble mind". In an interview, one of the famous Australian economists Stephen Koukoulas (with over more than 25 years of professional experience as an economist in government, as Global Head of economic and market research, a Chief Economist for two major banks and as economic advisor to the Prime Minister) asked simple question:
''What would you prefer? House prices three times' average incomes with 13 per cent interest rates or house prices four or five times' average incomes with interest rates under 7 per cent?
''The bottom line is the repayments are roughly the same.''
Economics used to be a science, not opinion field, so lets see how good scientist one of the Australian most famous economists really is.

According to RBA 1982 was the last year when Standard Variable interest rate was 13% and ratio between an average house price and average income was 3. An average repayment after purchase was 33% of the income (25 year loan, 80% LVR, deposit equal to 60% of annual income). 

Today, ratio between an average house price and average income is around 7 (according to RBA). Standard variable interest rate is 5.95%, repayment 45% of income (30 years loan, 90% LVR, deposit 70% of annual income).

First year repayment today is 36% higher than what it was when home prices were 3 times income and IR 13%.

But that is not the end of the story. Houses take decades to repay, so let see how repayments change over time.

In year 2, repayment was equal to 29% for 1982 buyer (IR dropped to 12.5%, income grew by 9%), and 43.5% for today's buyer (assuming IR and income growth stay the same). 

In year 3, repayment dropped to 25% of income for 1982 buyer (IR dropped to 12%, income grew by 11%) and 41.5% of income for today's buyer (assuming IR and income growth stay the same).

In year 4, repayment dropped to 23% of income for 1982 buyer (IR dropped to 11.5%, income grew by 5%) and 40% of income for today's buyer (assuming IR and income growth stay the same).

In year 5, repayment dropped to 21% of income for 1982 buyer (IR increased to 12%, income grew by 7%) and 38.5% of income for today's buyer (assuming IR and income growth stay the same).

Total cost of house ownership (including deposit) in first 5 years was 190% of income for 1982 buyer and 280% for today's buyer. Despite significantly lower rates, higher LVR and longer loan term, houses today are 47% more expensive in first 5 years than they were in 1982.

Over the life time of a mortgage (25 vs 30 years), today's potential buyer (with assumption that rates stay low) would pay more than twice in income terms for an average house than buyer from 1982.  

Economist Stephen Koukoulas says the anxiety about overpriced housing is overblown because the burden of today's big home loans has been completely offset by the saving from low interest rates.

Completely offset?
Don't worry and buy because "anxiety about overpriced housing is overblown"?!


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