As the housing market continues to heat up and higher interest rates continue to make homeowners sweat, many home buyers are asking the big question: Is now the time to invest in real estate?
Let’s take a look at what it means to buy property at a time of high interest rates.
What happens to house prices with high interest rates?
When we see higher interest rates, we usually see house prices drop because the increasing price of mortgage payments tends to lower demand in the housing market. As people’s monthly mortgage payments increase and repayments become more expensive, fewer people in the housing market should mean less competition and lower prices.
As the federal Reserve Bank of Australia has raised the cash rate and mortgage interest rates have increased in turn, we have seen a slight decline in property prices as mortgage rates have risen.
In turn, when we see lower interest rates, the usual pattern is to see an increase in house prices. This is because people’s monthly payments go down, their home equity goes up, and the reality of lower rates tends to see an influx of people into the real estate market. This means not just first-home buyers but also plenty of homebuyers looking for investment properties.
We have high interest rates — why is real estate still so expensive?
Unfortunately, the Australian housing market is in a unique situation right now, where demand outstrips supply. This means that in the short term, we often see home prices inflate in spite of rate hikes. Supply and demand are major factors influencing the property market and can lead to home values increasing due to competition instead of the lower prices we would expect.
This is particularly true in Australia’s metropolitan hubs of Sydney and Melbourne, where competition remains at a high. First-time home buyers may feel isolated from the prospect of homeownership, which needs a massive down payment as a barrier to entry, but the competitive rental market means that investment property remains as lucrative as ever.
This may also be partially owing to the ongoing impacts of the global pandemic on the Australian property market, which significantly shifted to demographic of homeowners and renters in Australia as well as drastically shifting many people’s financial situations.
The RBA’s interest rate increases do not impact mortgage rates instantaneously, so it may take a few months to see the trickle-on effect of any changes to the interest rate environment.
What happens if I get a home loan while there are high interest rates?
Taking out a home loan at a time of high interest rates will make a big difference to your repayments in the long run.
If you opt for a variable-rate home loan, you could find yourself very quickly facing rate hikes and increasing mortgage payments (if we see the RBA begin to lower rates, you may see the reverse of this as well). If rates rise while you are locked into a fixed rate home loan, you could find yourself very quickly looking to refinance at the end of a fixed period.
Sometimes a higher-priced home may be worth it if you can score a lower interest rate. Alternatively, if you are able to find real estate with a good enough price, a higher interest rate may end up being worthwhile. It may be worth consulting a mortgage broker or comparing them directly.
Consider the difference between a mortgage of $700,000 with a 4% p.a interest rate, and a home loan of $600,000 with a 6% p.a. interest rate. We will use the same loan term of 30 years and assume no refinancing or loan fees in this scenario. Though one loan amount is $100,000 more, it also has a much lower interest rate.
The $700,000 home loan will end with $503,087 interest payable at the end of the 30-year loan term (totalling $1,203,087), while the $600,000 home loan will end up with $695,029 interest payable (totalling $1,295,029). Even though the second home loan was $100,000 cheaper initially, it would end up costing nearly $100,000 more over the same period — and that’s with just a 2% p.a. difference in mortgage rates.
Reminders for home buyers with high interest rates
If you are getting ready to buy a house in Australia, there are some things to keep in mind while interest rates remain high.
A lot can change over the course of your home loan, with the interest rate environment constantly in flux. This is one of the reasons that mortgage lenders check not only your credit score but also generally consider your ability to make repayments should interest rates rise. Banks in Australia are obligated to apply a 3% buffer to the interest rate you apply for when considering your home loan application to ensure you will be able to make monthly payments in the case of rate changes.
Certain costs associated with your mortgage can also impact your interest rate. If you are buying while mortgage rates are high, you may want to save yourself from these additional interest rate boosts. Closing costs, for instance, can affect your interest rate. You may find low closing costs on real estate for a higher interest rate, which could be a poor exchange in the long run.
Can I refinance to a lower interest rate later?
If you are looking into a home loan with a higher interest rate, you might be planning on refinancing further down the path.
This is a potential option for many homeowners, as refinancing allows you to switch to a mortgage with different features or a lower rate, but it is not without its own complications.
You will need to be eligible for a refinance home loan, and it’s impossible to ensure that you will be in the future. This relies on you retaining a good credit score and meeting any requirements that may be provided by a future mortgage lender.
Many people end up as so-called “mortgage prisoners”, where they cannot meet the required 3% buffer interest rate hikes and are unable to demonstrate home loan serviceability. This leaves them stuck on their existing mortgage, with their current monthly mortgage payment already potentially rising.
Some borrowers may opt for a buydown, which is a way to get a lower mortgage rate by making an upfront payment. These can be negotiated at the lender’s discretion and can be beneficial to a borrower as they are a one-time payment as opposed to an interest payment over the loan term.
If you are choosing to buy a home with a high interest rate, you want to make sure you do not end up trapped and unable to refinance or complete a buydown, as these options may be unavailable.