The rate is normal; the debt isn't

On Tuesday the Reserve Bank's Monetary Policy Board raised the cash rate by 25 basis points to 4.60 per cent, its fourth increase this year. The decision was unanimous, and the statement kept the door open to more. The commentary wrote itself within the hour: mortgage agony, borrowers crushed, families at breaking point.

Underneath the noise sits a puzzle worth taking seriously. By any historical standard, these rates are not high.

Run the tape back. Through 2006 the cash rate moved between 5.50 and 6.25 per cent, and it was ordinary news, not a national emergency. It reached 6.75 per cent in late 2007 and 7.25 per cent through the middle of 2008. Even in December 2008, three months into the emergency cuts of the global financial crisis, the cash rate was still 4.25 per cent, only 35 basis points below where we sit today. A borrower from 2006, transported to 2026, would look at 4.60 per cent and call it unremarkable. Twenty years ago these levels were the neutral zone, arguably the easy side of it.

The reason a normal rate now feels like a punishment is that the loan it lands on is not normal.

The Reserve Bank publishes the ratio of housing debt to household disposable income in its statistical tables. At the end of 1996 Australian households owed housing debt equal to 53.1 per cent of a year's disposable income. By the end of 2006 it was 113.2 per cent. As of June this year it is 134.9 per cent. Relative to income, the nation's housing debt is now two and a half times what it was in the mid 1990s.

That ratio is the missing term in every argument about whether rates are high. A household's interest burden is not the rate. It is the rate multiplied by the debt. Run that multiplication as a rough index and today's 4.60 per cent takes about the same share of household income as a cash rate near 12 per cent would have taken from the households of 1996. It is a crude calculation, before lending margins, offset accounts and fixed loans, but the crudeness cuts both ways and the scale of the gap does not go away. We did not become more sensitive to interest rates because we grew soft. Every move by the Board now works on two and a half times the debt, so a 25 basis point rise today lands, relative to income, with roughly the weight a 60 basis point rise carried a generation ago.

And the household average, sobering as it is, flatters the situation at the margin. The 134.9 per cent figure spreads the debt across all households, including the many who own their homes outright or are decades into their loans. The person who meets today's rates at full strength is the one signing a new loan at today's prices: the first home buyer.

Our research at NestPath measured that buyer. Take a strong first home buying household by any honest standard: two people, both working full time, both earning their own city's median full time wage, no children, no other debts, and a 20 per cent deposit already saved. Hold their repayments to the standard 30 per cent of gross income stress line on a 30 year loan at the published average new owner occupier variable rate of 5.90 per cent. On those settings the couple cannot service the median house in five of Australia's eight capital cities. In Sydney they earn about $195,074 and servicing the median house requires an income of about $304,024, which is 1.56 times what two full median wages bring in. Brisbane falls about $44,000 of income short. Adelaide, long the affordable refuge, falls about $16,000 short. A bank might still write some of these loans, but the 30 per cent line exists because past it the rest of the budget starts giving way. What the same couple can still service, in all eight capitals, is the median unit, which tells you where the system is quietly steering an entire generation. The method and the city by city tables are at nestpath.com.au/research/the-double-income-wall.

Note the rate in that model: 5.90 per cent, the Reserve Bank's published average for new owner occupier variable loans as at March, before the May increase and before Tuesday's. If lenders pass both through in full, the same test runs at about 6.40 per cent, and the wall gets taller in every city.

Two conclusions follow, and neither is the one the commentary reaches for. The first is that the Board is not being cruel. Read the statement: inflation is still too high, energy prices are pushing it, capacity is tight, and the Board says plainly it will go further if needed. Whether 4.60 per cent is exactly neutral is a debate for economists, but it is not historically high, and anyone whose finances depend on a return to the emergency rates of the pandemic is waiting for something that will not arrive outside another emergency.

The second is that if the rate is ordinary and the pain is extraordinary, the rate is the trigger, not the cause. The cause is the stock of debt, which is another way of saying the price of housing. The Board's own statement notes that housing prices have fallen in most capital cities and new housing loans have declined noticeably. None of that repays a dollar anyone already owes. But it does mean new borrowing is shrinking relative to incomes, and the flow of new loans is the only place the stock of debt ever starts to correct. The market is slowly repricing toward what incomes can actually service, and it is happening while rates sit at levels our parents would have shrugged at.

For first home buyers the practical reality is unglamorous. The numbers that deserve trust are the ones that still work at today's rate plus a margin, because the cuts that would rescue an overstretched loan are precisely what the Board has just said not to count on. For the policy debate the lesson is larger. Every year we argue about whether rates are too high, and every year the debt that makes any rate feel high compounds quietly underneath. Rates have come back to normal. The debt has not. Until we are willing to argue about the second number, the argument about the first will keep missing the point.