There’s a saying that people will do more to avoid pain, than they will to gain pleasure.
Rising interest rates can be painful so I know all my readers will be interested in this topic!
Here are three scenarios to help clients better understand the consequences of a rising interest rate environment, and then plan accordingly…
#1 – The bank may not honour your pre-approval
- People who got pre-approved last year, or earlier this year, and went to their maximum borrowing capacity, will no longer be able to borrow as much money now.
- Both variable and fixed interest rates have gone up, and to formalise a loan the bank needs to reassess each application.
- When banks reassess applications using the higher interest rates, the clients’ borrowing capacity naturally falls.
- This mostly impacts borrowers who went to their maximum limits, however I’m still encouraging all clients to check in with myself or the team prior to bidding/ buying.
- The last thing we want is for clients to commit to properties, only to then be left with a shortfall in their funding requirement.
#2 – Your repayments are set to rise
- It wasn’t uncommon last year for clients to lock in 2/3/4yr fixed home loan rates at c 2 per cent.
- The equivalent rates are now c 3.5-4.5 per cent, and variable rates (currently c 2.5 per cent) could be around the same level in a couple of years from now as well.
- Say someone locked in for 2 yrs at 2 per cent last year, and their rate reverts to 4 per cent at the end of next year – on a $1M mortgage P&I repayments would increase by c $1,000/mth ($12k/yr, in after tax dollars).
- People will feel this.
#3 – Investors may be unable to extend their Interest Only periods
- Interest Only repayments are a common choice for investors, because they enable borrowers to maximise gearing benefits, at the same time as improving cash flow.
- However nowadays Interest Only repayments are only set for a maximum term of 5 years, after which time borrowers need to reapply if they wish to continue with this repayment method.
- The problem is that many borrowers may be unable to qualify for Interest Only terms again (due to lack of serviceability, as a result of the higher interest rate environment).
- For some, this might mean having to accept P&I repayments, which are higher.
- For others, this might also mean being unable to extend the loan term, for example back out to 30 years (over and above the P&I reversion), making the repayments higher again.
- To explain this one in a bit more detail, take a $1M Interest Only loan currently at 3 per cent with 27 years to go, and 2 yrs worth of Interest Only payments to go.
- Then assume the P&I rate is 4.5 per cent when the Interest Only period ends, and the borrower is unable to refinance – meaning their P&I repayments are based on a 25 year pay back period.
- Repayments would increase from $2,500/mth (Interest Only), to $5,558/mth (P&I) – well over double. This would clearly place a lot of pressure on the investor.
- Again this won’t be relevant for all investors or Interest Only borrowers, only those who are unable to refinance, and/ or who don’t have sufficient cash buffers in place.
Some key takeaways
- As a general rule, it’s prudent not to overextend when there is a threat of significant interest rate rises
- I’m encouraging clients to stress test repayments at interest rates 1-2 per cent higher than the current levels (the banks do this themselves when assessing applications, but clients should do the same)
- If interest rates do rise by 1.5 – 2 per cent over the coming years then all else equal one would expect downward pressure on housing markets across the country
- This doesn’t mean clients should ‘not buy’… it’s more about borrowing and buying sensibly
- Also if interest rates eventually come back down, and/ or if wages growth accelerates further, there may in fact be minimal impact on borrowing capacity
- We’re shifting from a sellers market to a buyers market
- If the property market pulls back, the availability of good quality housing stock being available for sale might reduce too
- Again as a generalisation, if you find the right property, you’ve got a long term view, and you’re not overcommitting, then buying conditions/ opportunities are probably looking quite good
- If you’re worried about how the threat of higher interest rates might impact you, there are plenty of ways to plan ahead and protect your position (think risk insurance, building up savings buffers, etc.) – please get in touch with me to discuss further
- It’s not all doom and gloom… business conditions are strong, unemployment is low, savings are high, wages are increasing, rents are increasing, our borders are opening back up, and interest rates are still very cheap, even if they do rise 1.5 – 2 per cent from their current levels
I was fortunate to present yesterday at the Mortgage & Finance Association of Australia (MFAA) National Conference and my key message to brokers was that now more than ever we need to double down on our communication with clients.
We need to help clients strategize and help them make more informed and confident property and finance decisions moving forward.
To discuss how any of this impacts your personal circumstances feel free to book a call or ZOOM with me any time – www.calendly.com/dangold
Thanks and best wishes.
Daniel Gold
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This article provides general information only and has been prepared without taking into account your objectives, financial situation or needs. We recommend that you consider whether it is appropriate for your circumstances and your full financial situation will need to be reviewed prior to acceptance of any offer or product. Nothing here constitutes legal, tax or financial advice and you should always seek professional advice in relation to your individual circumstances.
