As early as the first days of the pandemic, Reserve Bank governor Phil Lowe reduced the cash rate to only 0.1 per cent and promised to keep it there until 2024, many Australians took him at his word. House prices climbed to levels never before seen, and many people took on loans that were previously unheard of.
Interest rates are now projected to rise, possibly as soon as next week when the Reserve Bank meets.
According to the Bureau of Labor Statistics, inflation is currently running at 5.1 per cent, the highest rate in more than two decades. The big four banks anticipate that borrowers will be paying an interest rate of approximately 5% by the end of next year, an increase from the current rate of 3%. If bond markets are correct, borrowers could be forced to pay interest rates of more than 6 percent. It’s enough to give first-time homebuyers a case of whiplash.
When it comes to rising interest rates, should borrowers be concerned? It is highly dependent on the date of purchase.
The majority of homeowners who purchased their homes before the epidemic are not overly concerned. The combination of rising house prices and stagnating salaries has resulted in loans that are larger in proportion to incomes than they were during prior eras when interest rates were higher. However, the majority of borrowers’ interest payments will most likely return to where they were prior to the pandemic-era rate reductions.
Furthermore, many homeowners have taken advantage of the low interest rates over the previous two years to get ahead on their mortgage payments, continuing to make the same installments even after rates plummeted. The average homebuyer today is nearly two years ahead of schedule on their mortgage payments, compared to only 10 months ahead of schedule at the start of the pandemic.
According to the Reserve Bank of Australia, interest payments account for barely 4% of Australians’ total disposable incomes at the present time. In the event of a 2 percentage point increase in interest rates, Australians would still spend less than 8% of their incomes on interest payments – the same amount as in June 2019. Prior to interest costs returning to the peaks that they reached shortly before the global financial crisis in 2008, they would have to rise by 4 percentage points, to an average mortgage rate of more than 7 per cent, on an annualized basis.
This shows that increasing mortgage rates will not have a negative impact on the expenditure of the majority of borrowers.
It is not whether or not many Australians can afford their mortgage, but rather what will happen to the value of their home when interest rates rise, that is the more pressing matter.
In its forecast, the Reserve Bank anticipates that a 2 percent hike in interest rates from current levels would result in a 15% decrease in housing values, effectively reversing much of the gains made over the previous two years. Because many consumers had expected interest rates to remain low for a longer period of time, the long-term consequences could be even more severe. Homeowners who see a decrease in their home’s value feel impoverished. It is possible that this will have a greater influence on their expenditure than the impact of increased interest rates.
However, there is one set of people who are particularly sensitive to increasing interest rates: those who have recently purchased a home and borrowed to the maximum extent possible to do so. It was only in the previous two years that the average size of new housing loans increased by more than 20%, reaching a high point of $605,000 in December last year. A quarter of recent home buyers financed more than six times their annual salary, according to the National Association of Realtors. They are facing a double whammy: increased interest rates on large loans and higher borrowing costs. Several of these debtors will be left with negative equity in their homes if house values continue to decrease.
Consider the case of a recent homebuyer who obtained the typical loan and makes a pre-tax household income of $128,000 per year on average. Their mortgage payments as a percentage of their income would increase from around 26 percent to approximately 32 percent if their interest rate increased by 2 percent. A 3% increase would bring them into the 35 percent range, indicating that they are under housing hardship.
A sudden decrease in income or an increase in other expenses could cause them to fall behind on their mortgage payments, increasing their chances of defaulting.
The main fact is that, for the vast majority of borrowers, the return of higher interest rates will not be a significant source of distress. Many newer borrowers, on the other hand, will soon feel the squeeze. And if elder borrowers do not experience significant hardship, the Reserve Bank may be encouraged to boost interest rates even more quickly if inflation continues to be difficult to control.
A rising interest rate environment means you’re more than likely still unsure about the home-buying process. In order to make the process as easy as possible for you, Parag dixit, our morgage and financial expert, is here to help. So don’t hesitate to get in touch.
