Interest rate rises: how today compares with the 1990s

Surging mortgage interest rates are sparking some interesting conversations – and disturbing calculations.

The sharpest spike in home loan interest rates in decades has resulted in some strong discussions among different generations.

As young homebuyers with big mortgages are struggling with their first ever rate rises, some older Aussies wonder what the fuss is about.

It’s not quite as us-versus-them approach, although the view among some who dealt with monstrous interest rates in the 1990s has a bit of a “harden up, princess” flavour.

However, data and calculations show that the pressures facing today’s buyers and relatively recent borrowers are impossible to compare with previous periods.

A reader recently pointed out that the current 1.75 percentage points of rate rise since may are vastly different to the 17.5 per cent he paid in the 1990s. He acknowledged that houses were much cheaper back then and salaries were lower too.

It got me thinking about how the pain factor of today’s rises compares with the past, which led to some scary calculations.

Firstly, a current variable interest rate near 4 per cent on a typical $500,000 mortgage sets a borrower back about $2639 a month or $31,700 a year for a principal and interest loan.

A return to 1990s interest rates would leave borrowers with nothing.

That’s about one-third of the average full-time wage of just over $90,000 a year.

But what if variable interest rates today were 17.5 per cent?

Well, that would lift monthly repayments on the same $500,000 loan to $7388 a month, or about $88,700 – almost as much as Australia’s average full-time wage. Previous research found that in 1990, repayments represented about 48 per cent of average annual salaries.

Of course, rates today won’t rise anywhere near 17.5 per cent, but the above illustration shows just how much home values and mortgage sizes have outpaced wages growth.

The current cash rate of 1.85 per cent is widely tipped to peak near 2.6 per cent by early next year, although some forecasters say around 3 per cent is more likely.

Households are likely to soon be paying close to 5 per cent for mortgages, bad news for many that means hundreds of dollars must be found in household budgets to plug the gap.

The good news is that it should only be a temporary hit. Many economists forecast rates could start falling again during 2023, largely because the speed of rate rises is likely to slam the brakes on consumer and business spending, dramatically slow the economy, and put the inflation genie back in its bottle.

The delayed effect of the recent rate rises – banks usually take a month or two to pass them on – means the surge of RBA rises since May is only just starting to hit borrowers where it hurts.

Australia’s official inflation rate is also backward looking – the latest figure of 6.1 per cent is for the year to June 30. Economists believe it will rise further in the coming months, but by that time rates could be hitting borrowers hard and send it back down.

Nobody really knows what will happen, and when, but we can be grateful that today’s spate of rate rises won’t swallow a full-time worker’s entire wage.

Originally published as Interest rate rises: how today compares with the 1990s