Mortgage For The Nation

Newcastle Herald

Friday March 7, 2008

Jeff Corbett

WE all have a general idea of why the Reserve Bank raises interest rates, and it makes no bones about its purpose. That is to curb spending, and higher interest rates do that by giving us less money to spend.

Usually the Reserve Bank says something about easing inflationary pressures by decreasing the demand for goods, although it might not say it in precisely those words, and as we all know increasing demand over supply means increasing prices and, that dreaded bogy, increasing inflation.

The most prominent impact of the Reserve Bank's announcement that it is increasing its cash rate is an increase in home loan interest rates. Just by the way, why do the banks see increasing home loan rates after a Reserve Bank increase as much more urgent than decreasing the rates after a Reserve Bank decrease?

But back to the chase. Increasing the cash rate will mean a higher interest rate for personal loans and other loans, but this will apply only to new borrowers, not to existing borrowers. It will mean, too, a higher rate for property investors, and in time many will seek to pass that on to their tenants if they believe the market will bear it; for many property investors, though, a higher interest rate means a higher negative-gearing tax claim against their income.

It has been the Reserve Bank's intention in each of its 12 consecutive rate rises since mid-2002 to force home loan interest rates up, and it has done that to reduce the amount of money people with a home loan have to spend.

But, according to the 2006 census, only 32 per cent of households have a mortgage.

Does this mean that only one-third of households get stuck with the pain of fighting inflation? Certainly the Reserve Bank's intention is that they pay more to their bank so that they have less money to spend. And when you think about it, if only a third of households are spending less, that third will have to spend a lot less to cover for their more comfortable fellows who aren't spending less.

Hey, one effect of the Reserve Bank's increasing cash rate is, usually, an increase in interest paid to investors, and people without a mortgage are much more likely than those with a mortgage to have significant investments. So not only will people without a mortgage not be forced to curb their spending, they'll have more money to spend.

People with a home loan will have to spend even less to cover for their well-off neighbours' splurge, and so it goes on. And it has gone on: as I wrote, 12 increases since mid-2002 and four in the past seven months.

And newspapers report that some banks are planning to increase their home loan rates by more than the Reserve Bank's 0.25 percentage point, presumably because they believe they can get away with it.

No wonder many borrowers are under severe stress, and you may have read a Lifeline counsellor saying in this paper yesterday that some home buyers are considering suicide!

What's the Reserve Bank's take on this?

It says one intention of increasing the cash rate is to encourage prospective home buyers to delay the purchase or to buy a cheaper home, and that happens because at higher interest rates banks reduce the amount they'll lend.

Another intention is to reduce households' spending money, and in a paper headed Monetary Policy I found on its website the Reserve Bank agrees with much of what I've written above.

"The effects of changes in interest rates are different for debtor and creditor households: a rise in interest rates reduces the cash flow for debtors while raising it for creditor households," it says. But it notes that the increased spending by people without a mortgage would not fully offset the reduced spending of households paying more interest.

My account of the impact of the Reserve Bank's increasing its cash rate is necessarily simplistic, but my point that Australians with a home loan are carrying the can, a heavy can, for all Australia is fair.

Blog with Jeff @ www.theherald.com.au

In today's blog: I know nothing about monetary policy but I know a crook deal when I see it. Are you with me, or don't you have a mortgage?

jcorbett@theherald.com.au