Owning a home is part of the Australian dream. But whether we can afford it depends a lot on the cost. Expenses like mortgage interest, principal repayments, and stamp duty can really add up over time, so it’s no wonder rising interest rates may have homebuyers feeling uncertain.
Buyer sentiment and the cost of home loans can make big waves in the housing market. So what do rising rates mean for property long-term? Let’s unpack it.
Why are interest rates rising at the moment?
The Reserve Bank of Australia (RBA) is a government body in charge of monetary policy. They keep an eye on the economy and regulate it so we can avoid big booms and busts. One of the ways the RBA does this is by setting the official cash rate, which is used by banks to determine variable interest rates on their financial products, including home loans and savings accounts.
When the economy experiences significant inflation, the RBA will lift the cash rate to temper price rises. This increases interest rates on home loans and savings accounts, making the former more expensive and latter more attractive. Consumers then have financial incentive to save, rather than spend, their money, which can halt inflation.
On the other hand, if the economy heads for a recession, the RBA will cut the cash rate to encourage Australians to spend, borrow and invest, which gives the economy a shot of adrenaline.
During the pandemic, the Australian economy desperately needed a boost of cash. So, the RBA pushed the cash rate down to a record low 0.1% and held it there for a year and a half. Now that inflation is rising and the economy has picked up steam, we could see a few more cash rate hikes this year flow through to variable home loan rates.
Interest rates for home loans
Whenever the RBA lifts the official cash rate, it has both immediate and delayed effects on the property market. These can include:
- Higher variable interest rates for home loans
- Bigger home loan repayments, which can lead to mortgage stress
- Lower property prices due to falling demand
- Reduced home equity because of loss of value.
We may already be seeing some of the short-term fallout of the latest rate rise. All major banks in Australia have increased their home loan variable rates in response to the RBA rate hike.
As the cost of housing finance goes up, we may start to see long-term consequences soon.
Property prices
When home loans get more expensive due to rising interest rates, this has the potential to put off new buyers. This is because it reduces the amount they can borrow and makes it harder to pass loan serviceability tests.
Housing affordability is a big driver of demand. As mortgages get pricier and demand drops, so too could house prices.
As the cash rate continues to rise, variable mortgage rates will trend higher. This may further drive down property values across the country, especially in popular capitals like Sydney and Melbourne.
Home equity
While falling property prices may come as a relief to some, other homeowners may fear a potential loss of home equity. But what does this mean?
Home equity reflects the portion of your property you actually own while you’re paying off your mortgage. In other words, equity is the difference between what your home is worth and how much you have left to repay.
Paying off your loan will increase your equity, but so too will rising property values. However, if property values drop, your equity may decrease. This in turn can affect your ability to refinance or purchase another property. So whether you’re shopping for a home loan or already have one, equity is something to pay attention to.
To determine how much equity you have, you’ll need to find out how much your property is worth. You can do this by hiring an appraiser or looking at other recent sales in your neighbourhood for an estimate.
Why is it important to pay attention to interest rates?
While it’s part of the deal that your variable home loan may change over time, it’s still important to stress test your mortgage against any future rises. Try using a rate change calculator to see how higher interest rates could affect your repayments.
Budgeting for these shifts and understanding how they affect the larger property market will also help you with your mortgage repayments long-term. Watching interest rates is one of the key ways to break into the property market – and stay there for good.
Evlin DuBose is a personal finance writer at the financial comparison site mozo.com.au.