Will rising rates hurt as much as some think?
Inflation, higher fixed and variable rates, tighter lending conditions and worsening affordability are all contributing factors causing many experts to believe that residential property prices will fall significantly. But will it all be as bad as what some think? Or will it be an orderly downturn, with somewhat normal conditions, that present short-term opportunities for some including investors and first home buyers?
A massive jump in variable rates and how much higher will they go?
Recent inflation data has triggered the Reserve Bank of Australia (RBA) this month of June, to lift the cash rate by 0.5 per cent – the largest monthly increase in 22 years. Sentiment amongst a few leading economists is that the RBA may lift the cash rate again by .5 per cent in July and continue to increase rates, by not as much though, each month this year.
From a historical perspective, rates are still very low but with COVID-related disruptions, the war in Ukraine, the floods, prices for electricity, gas, petrol and even lettuce, inflation has increased significantly and is expected to increase further. Goldman Sachs chief economist Andrew Boak, who predicted the .5 most recent RBA increase, believes the cash rate will increase to 2.6 per cent by December this year, and continue increasing into 2023. Whereas Westpac on the other hand, and the Australian major banks, are more so leaning to a 1.75-2 per cent December cash rate, and 2.25-2.5 per cent next year.
What do higher variable rates look like?
Principal and interest repaying, owner occupied loans, will increase from an average competitive rate of 2.39, to 2.89 per cent given most if not all lenders passed on the full recent .5 per cent rate hike. See the impacts below and also what it will look like if the RBA increases their rates again by .5 per cent in July next month, or later in the year:
By how much will these rate hikes impact my borrowing capacity?
Higher interest rates not only increase our repayments but importantly, lower our borrowing capacity. The banks apply a sensitised 3 per cent buffer, on top of the interest rate we’re applying for when determining our ability to make future repayments. The Australian Prudential and Regulation Authority (APRA) made this change in October 2021 for all the banks, increasing the buffer from 2.5 per cent. So, when the banks are looking at what we can afford to borrow, when applying for a variable rate owner occupied loan making principal and interest repayments, they’re now working it out at a buffer rate of 5.89 per cent (2.89 + 3) – it’s high as you can see, and going to go higher.
We’ve already seen this challenge of late, with fixed rates that have skyrocketed but now we will begin to experience the same, with variable rates.
Fixed rates have skyrocketed already off the back of government bond yield spikes after governments around the world pulled back from their quantitative easing programs. This is why fixed rates have increased independently of RBA movements and each lenders response has been different. 2 year fixed rate owner occupied loan buffer rates are 7.39 per cent (4.39+3), so if you’re applying for a fixed rate loan or have a large portion of your loan fixed, it’s going to be detrimental to your borrowing capacity as the bank is working out your future repayment ability at this higher rate. From a servicing perspective, the more we allocate to fixed, the worse it is.
Does it make sense to fix now?
If you’re thinking of deciding to fix more of your loan now to safeguard against future rate rises, or proceed with more of a variable loan split, it’s definitely case by case and depends on individual circumstances. These fixed rates are already very high. It’s important we understand each persons’ goals and objectives, to explore the many lenders we have on our panel and work out what’s in your best interests. A deep dive into knowing what you need and want to achieve, is critical, to knowing how to tackle this.
A good time to tap into equity, buy a home or invest?
As interest rates are likely to increase, it could be a good idea when maintaining a realistic long term focus, to tap into the equity available in your home now, to explore borrowing capacities before they get even tighter, and with rents on the rise and rental vacancies low, it could be a time to consider an investment purchase.
There’s a mini boom occurring in the Australian rental market. According to Corelogic, rental incomes increased by close to 10 percent nationally, over the year. While this is positive for the investor, it’s not from a rental affordability perspective in a time when households will have less income with higher living costs, available for rent. A tricky one for our government to manage.
With interest rates rising, it could also mean that rents continue to rise which could support the notion that an investment property is a good idea and if prices do drop a little, it could make even more sense.
Prices have already started to correct a little which is encouraging not only for the investor, but also for the first home buyer and with the host of initiatives available from the government, it could be positive news for them if servicing requirements can be met. As you can see from the data, even though it’s on the downward trend, we’ve still got growth in Brisbane and Adelaide, but a tiny drop in Sydney and Melbourne, looking at Corelogic’s rolling quarterly change in dwelling values.
Higher interest rates will lower borrowing capacities and will most likely see less demand for properties as more supply isn’t met by the decreased demand. AMP’s Capital chief economist says that Australia should expect a 10-15 per cent drop in house prices in some areas over the next 18 months. If these predictions hold true, it will definitely help the first home buyer – if they can service their debt. And with the first home buyer initiatives on offer from the government, including the First Home Guarantee scheme and it’s increase to the property price caps, this segment will be well supported and encouraged. Economists suggest these initiatives could cushion a downward spiral trend given these first home buyers will be there, with strong demand to pick up the slack and keep property prices at moderate levels in this segment.
There are also the Labor government’s new first home owner initiatives which includes the Regional Guarantee Scheme and a Home Equity Scheme which they labelled, Help to Buy. We will know more about these soon and have information available. At a high level though, Help to Buy is supporting eligible first home buyers with only the need to save a deposit of 2 per cent. The Federal Government will support this segment with an equity contribution up to a maximum of 40 per cent of the purchase price of a new home, and up to a maximum of 30 per cent of the purchase price for an existing home.
These first home owner schemes though are “first in best dressed” initiatives with limited spots available. Yes, this time, there are more spots available but it’s extremely competitive and spots run out quickly, so you should contact your broker (us here at Black & White Finance) about it now to ensure an adequate plan is put in place for 1 July this year.
Final thoughts
Higher fixed and variable rates, tighter lending conditions, and cost of living pressures, have already contributed to a slowdown of late. It is in our opinion though that the downturn will be more of a correction, not a crash and that there will be different impacts to different parts of the country. Opportunities will present themselves for some and it’s more important now than ever, to ensure the most suitable loan structure in your best interests, is in place for you, to tackle all of this.
If you want to know more about the different rates, terms, or bank specials on offer at the moment or just have a general question, please send a note to peter@blackandwhitefinance.com.au or click the start today button a little lower. With the help of our amazing team, we will be able to support you.
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