‘THINK MORTGAGE RATES are high now? They’re nothing compared to the 1980s.’
If you’re a prospective home buyer, you’ve likely heard or read some variation of this statement while looking on in anguish at constantly increasing mortgage rates.
While mainstream Irish banks have been slow to pass on European Central Bank rate hikes to customers, borrowing costs have still jumped over the last year.
For much of the last decade up to 2022, first-time buyers could avail of rates of between 2% to 3%.
But as of now, mortgage rates on loans for new borrowers have jumped to around 4.5%, with AIB and Permanent TSB both announcing recent price hikes.
With the ECB still struggling to get eurozone inflation under control, it’s likely the rates on offer for first time buyers will finish 2023 even higher again.
This increase of around 2% may not sound like much. Especially in comparison to historical interest rates, which were at double-digits throughout the 1980s.
Plenty of horror stories have been dug up recently of terrifying rates near 16%, which peaked in the early 1980s in Ireland and have been largely on a downward trend since.
There is no doubt many older homeowners struggled to buy decades ago. But the headline interest rate doesn’t tell the full story.
House buyers now tend to borrow much more compared to their peers in the 1980s.
This means interest rate rises have a much greater impact on how much money they have left over at the end of each month.
To illustrate this, Dara Turnbull, an economist for Housing Europe, looked at an example in detail for The Journal.
He took a ‘typical’ first-time buying couple in 1987 – two people aged under 35 with no children – and compared it to one in 2022. Old Irish pounds were converted to euros.
Both were assumed to be buying an average-priced home on a ‘typical’ wage using 10% deposit and a 25-year loan.
For the 1987 couple, this meant their gross income was just under €25,000 while the home they were buying was worth €42,700.
For 2022, their joint income was €83,000, while the home they bought was €331,000.
The 1987 couple faced interest rates of 11.3%, more than triple the average interest rate of 3.1% in 2022.
Despite this, the 2022 couple still ended up spending far more of their income on mortgage payments.
“In 1987, they would have been spending 17.4% of their average disposable income (after tax) on mortgage payments,” Turnbull said.
“For the couple in 2022, it would be 25.8% of their disposable income.”
So why is there such a big difference, despite the much higher mortgage rates for the 1987 couple?
A major one is mortgage interest relief. Until 2013, the state effectively subsidised mortgages. House buyers got relief to the tune of thousands of euro per year.
But this doesn’t fully account for the difference – the other big factor is how much more debt buyers in 2022 have.
Neal Hudson, the founder of housing consultancy Builtplace, said because houses are more expensive now relative to earnings, people have to take out bigger mortgages.
“The key thing is that people used to borrow about two times their income, but now it’s about 3.5, four times their income,” he said.
So when interest rates go up, it has a bigger impact on current buyers.
Hudson said this means it is essentially impossible for interest rates to return to the levels seen in the 1980s.
“If rates went back to 12 or 15%, you would be looking at a massive destruction of asset value,” he said, as repayments would surge and become completely unaffordable.
“Property values would fall and there would be a severe depression before you even got to double-digit rates.
Low interest rates are embedded into the market.”
Hudson and Turnbull both said how much disposable income is being spent on housing demonstrates the different world modern buyers face.
The example from Turnbull showed that even with a 3% interest rate, the modern couple would spend much more of what they earn on their mortgage compared to a buyer in the 1980s.
If the 2022 couple borrowed at an interest rate of 5%, their repayments would jump to almost €21,000 a year.
This works out at 31.5% of their after-tax income – far more than the 17.4% disposable income in 1987, despite the fact that interest rates were much higher.
This is a major difference between now and decades ago.
Modern households were already using more of their disposable income to pay for their home, even before the big round of rate hikes.
“In part, that’s because of the higher cost of housing generally,” Turnbull said.
“An average house bought in 1987 would cost about €80,000 now if earnings increased at the same rate, but of course the average price of a home isn’t anywhere near that. It’s also due to mortgage interest relief as well.
“Fundamentally, this generation compared to the previous one is paying more in mortgage costs.”
To embed this post, copy the code below on your site
have your say