The Progressive Mortgage Rate System
A Proposal on a New Household Interest Rate System to Solve the Current Cost of Living Crisis
J. C. Lai
Australia’s surging inflation rates have reached record highs since 1990, which has required steep cash rate hikes by the Reserve Bank to tame inflation back to its targeted range of 2-3%. Unfortunately, these interest rate rises have fuelled Australia’s cost of living crisis, crushing households and mortgage holders on variable mortgage rates. To make matters worse, rises in the official cash rate is regressive as it disproportionately impacts those who are less equipped to take on higher interest repayments more, which damages Australia’s income equality and living standards. This article proposes a solution to this problem through the implementation of a progressive mortgage rate system on homeowners, similar to Australia’s progressive taxation system, to ensure greater parity in Australia’s housing market.
Inflation rates hit 7.8% in the December quarter as a result of excessive corporate profits, post-pandemic demand surges, and supply-side shortages. This has led to a decline in the material living standards of ordinary Australians, with real wages falling 2.7%, which marked the worst result in more than two decades. The Reserve Bank has responded to this in the same manner as other Central Banks around the world through a contractionary monetary policy stance in the form of an increased cash rate. Nine “extreme” consecutive interest rate hikes have seen the OCR rising from its historic low of 0.1% to 3.35% as an attempt to take demand out of the economy and encourage saving.
This has had aggravating consequences for low to middle income homeowners, compounding onto the already existing cost-of-living crisis due to the drastic fall in real wages. Considering that nearly 70% of Australia’s mortgages consist of variable rates, with many more on short term fixed rates that are soon to roll off onto variable rates, homeowners will be forced to rein in spending to pay off substantial increases in interest repayments at the risk of defaulting on their mortgages.
A financial stability review conducted by the RBA in October, 2022, raised significant concerns towards low-end homeowners. Using the projected OCR of 3.6% in the coming months, the review found that over half of all homeowners (mostly comprised of low to middle income households) would see a reduction in spare cash flow exceeding 20%, and over 15% of all homeowners would see their cash flow going into the negatives, meaning they won’t have enough money to cover their mortgages, let alone other necessary expenses, such as food and energy. Since low to middle income homeowners have a higher average propensity to consume compared to higher income homeowners, they will not possess large saving buffers and are therefore less equipped to take on the higher interest repayments and the decrease in cash flow. Therefore, the recent and impending OCR raises will have regressive impacts towards the economy and worsen income equality, making the need for alternative solutions necessary to prevent a default crisis and drastic decreases in living standards.
The proposed theory is based on the fact that the current household mortgage repayment system is detrimental to lower income households as it is regressive, and therefore the government should implement regulations towards banks to promote a more progressive system by factoring in an individual’s income. This means that household interest rates will be under various brackets similar to the progressive tax system, where rates rise as wages increase.
This system safeguards those who are more in need of disposal cash flow to fund their necessary expenses, whilst demanding more from those who possess large saving buffers and are more readily-prepared to take on larger interest repayments. This reduces the risk of default for financial institutions by tailoring repayments to a borrower’s financial circumstances, whilst ensuring that banks are generating unchanged incomes from mortgage repayments, as the reduction in low-income households are offset by the increase in mortgage repayments by high income earners.
Furthermore, by only implementing this variable interest rate model to the household sector, it ensures that monetary policy still remains effective across the overall economy, as it still trickles down through the transmission mechanism and into other interest rates across the economy. The obtaining of a household’s income will also not pose a problem, since it is already collected by the ATO for taxation purposes, and therefore the government can implement channels where the information is passed onto banks to determine the appropriate mortgage repayment for a particular household.
The implementation of a progressive mortgage rate system could represent a step forward in addressing financial inequality within Australia’s economy and ensure that there is adequate cash flow to all households regardless of income level, solving Australia’s current cost of living crisis.