Housing affordability in Australia is likely to worsen as the impact of higher interest rates outweighs the benefit of falling prices, Moody’s says.

The ratings agency said Australian households with two incomes needed 26.8 per cent of monthly income to meet monthly repayments on new mortgages in May, up from 25.7 per cent in January.

This measure of housing affordability deteriorated in all capital cities over the period and was worse for houses than apartments.

In Sydney, new borrowers needed 37 per cent of household income to meet mortgage repayments in May, while in Melbourne they needed 29.8 per cent, in Brisbane 23.1 per cent, in Adelaide also 23.1 per cent and in Perth 16.3 per cent.

Comparing houses and apartments, house buyers needed 30.2 per cent of household income to meet mortgage repayments in May, compared with 21.4 per cent for apartment buyers.

“Home loan interest rates will continue to increase this year along with RBA rate rises, which will worsen housing affordability,” Moody’s said.

“We expect housing prices to decline over the rest of this year and into 2023 as rising interest rates weigh on property market sentiment. However, based on our assessment of different housing price and interest rate scenarios, we expect that prices will not decline to the extent that housing affordability improves.”

The firm’s modelling indicates that if the cash rate rises to 2.85 per cent this year, housing affordability will only improve if prices fall by more than 20 per cent, which is a materially bigger decline than it expects by the end of this year.

The largest sustained decline in average Australian house prices in the past decade was 8.6 per cent over the two years to June 2019.

Moody’s expects household incomes to rise this year but not by enough to improve affordability.

“Rising interest rates will overshadow higher incomes in addition to housing price declines,” it said.