What happens if interest rates rise, and how does one strategize…?
In terms of the expectations of some of Australia’s most respected interest rate commentators, they generally see higher interest rates moving forward, but not quite as high as the market is currently pricing.
For example last week Westpac’s Bill Evans revised the bank’s projections to include five rate hikes between June to December this year, a cash rate at 1.25 per cent by years end, and a peak rate of 2.0 per cent for this rate cycle (the RBA cash rate is currently at 0.10 per cent).
Meanwhile, CBA and UBS don’t believe the cash rate will rise so aggressively, suggesting the terminal level would be closer to around 1.25 or 1.5 per cent.
With this backdrop, I thought I’d run some numbers on what happens if interest rates rise by 1 or 2 per cent from their current levels…
Existing loan repayments increase
For a 1.0 million dollar home loan:
- Assuming an eventual 1.0 per cent rate rise, monthly repayments increase by $530 per month (just over $6,000 per year)
- Assuming an eventual 2.0 per cent rate rise, monthly repayments increase by $1,097 per month (just over $13,000 per year)
Double these figures for a 2.0 million home loan.
* Calculated based on a 30-year principal & interest (P&I) home loan, starting interest rate 2.25 per cent.
Borrowing capacity decreases
Often overlooked is that as rates rise the banks don’t allow clients to borrow as much money…
For a single borrower earning $100k per annum, with Nil dependants, average living expenses, a $6k credit card, and Nil other debts, borrowing capacity reduces from:
- $675,000 to $610,000 (10% drop), assuming a 1.0 per cent rate rise; or
- $675,000 to $550,000 (18.5% drop), assuming a 2.0 per cent rate rise
For a couple earning a combined income of $250k per annum, with 2 x dependants, average living expenses, a 10k credit card, and Nil other debts, borrowing capacity reduces from:
- $1.7 mil to $1.525 mil (10% drop), assuming a 1.0 per cent rate rise; or
- $1.7 mil to $1.375 mil (19% drop), assuming a 2.0 per cent rate rise
* Calculated using NAB broker servicing calculator on 10 April 2022, starting interest rate 2.25 per cent, couple income split 50/50, assumes no other changes for example to credit policy, assessment rates, etc.
Readers can draw their own conclusions here, but appreciate it’s far more complex than just assuming higher interest rates lead to lower house prices.
The outlook for housing clearly faces headwinds, however, there are still many factors providing comfort…
For example, household savings are at record levels, and many homeowners have substantial equity in their homes now.
According to CoreLogic, the estimated value of the residential real estate in Australia is now 9.8 trillion, versus outstanding mortgage debt of only 2.0 trillion.
So certain segments of the housing market may be less sensitive to rising interest rates than we’re led to believe, and the average Australian is wealthier now than ever.
Our economy is growing, overseas migration is picking up, and rising rents are likely to bring more investors back into the market soon.
The Australian banking system is sound and most lenders have issued finance on the basis that the borrower can withstand at least a 2.5 per cent rate increase relative to their actual interest rate.
There is a shortage of high-quality properties currently available and if the property market falls query how the stock levels for top properties could really pick up?
Millennials have been struggling to buy into many of the better middle ring suburbs because empty-nester Baby Boomers are still staying put.
Boomers are expected to only start selling at scale in the 2030s when their health makes the family home a physical hazard.
My personal view
It’s important to seek specific advice based on your individual circumstances, but in general, terms, if you’re buying an owner-occupied property, you’re in a sound financial position, and you’ve got a longer-term horizon, then it rarely makes sense to try to time the market.
For investors, there may be less urgency right now, however, it can never hurt to study the markets and be prepared to pursue anything which might come about opportunistically.
I advise my clients to at the very least organise pre-approvals, set up alerts on the web portals, and then inspect properties, track sales results, etc.
Regardless of timing, investors can always pay close attention to any rare finds which may not become available again soon and/ or which can be bought well.
And as a general comment in an environment where interest rates are likely to rise, it makes sense not to be too aggressively leveraged.