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Impact of Rising Interest Rates on Property Investments

The Reserve Bank of Australia (RBA) has implemented interest rate increases for five consecutive months to curb inflation, which has spiked notably with the passing of the global pandemic and accompanying lockdowns. 

The RBA’s most recent increase was in September of 2022, when it raised cash rates by a further .5 percentage points, bringing interest rates to 2.35 percent. 

While the increase was felt across the economy, homeowners with mortgages and property market investors got the bulk of the impact. 

More to Come

More ominously, the consensus is that this rate increase is not the last of this year. Higher rates will stifle inflationary growth and dampen enthusiasm for taking out loans to buy a house. For investors, it means property values will likely start to decrease. 

While that has an upside for those looking to buy in the future, those who bought in the recent past are now likely to see a decrease in the value of their investment. That decrease in value comes as loan repayment costs increase and since Australians know this isn’t the end of it, many home buyers and investors are taking a step back and reconsidering their options.

Interest Rates vs. Home Prices

Reduced housing prices are great news for those contemplating getting into property investment that does not have to go through lenders to secure funding for the property. The flip side to that equation is more expensive loans.

Another group that may not like the new market, even with lower home prices, is those shopping for a home that needs bank funding. Changes in the RBA cash rate influence lender’s bank deposit rates, which help determine interest rates for home loans. The recent increases to maintain banks’ profitability rates have made loans significantly more expensive.

The more expensive loans have made home ownership unaffordable for many people looking to buy a home or invest in property. The hardest hit will be (and are) first home buyers because their overall borrowing capacity is limited to begin with in most cases. Home ownership may be put on hold for that market segment until the inflation and economic pressures subside.

If, for example, after the mortgage and living expenses are covered, a couple only has a few hundred for savings or spending, stacking on perhaps an additional $70 a month might be a deal breaker. It might mean reconsidering if ownership is a legitimate goal. It also might make repayment less of an assured outcome.

Necessary Measures

The increase in the cash rate was, however, necessary to keep spending in check. Significant inflation rates of 6.1% and expected upward are the result of restarting the post-pandemic economy, lingering supply chain issues created by the pandemic, and the impact of the Russia-Ukraine war. 

Interest rate rises, among other changes in the economic situation, has increased the cost of loans while lowering median prices, according to CoreLogic’s recent data analysis. The median property prices for key cities like Sydney, Melbourne, and Brisbane have reduced as the buyer market has begun to dry up, which has lowered prices even further. 

Impact on Property Investments

Higher interest rates mean mortgage repayments have become significantly more expensive. While major commercial property investors might not be impacted as quickly by higher loan repayments, the overall impact of more expensive loans means that commercial and residential borrowers have less borrowing capacity. 

These added expenses are prompting many borrowers to examine their investment strategy and alter it where they can. The only viable option is to reduce their cost of living to make mortgage payments more affordable.

By trimming expenses to make loan payments more affordable, ownership is still a possibility. Borrowers may also have to accept that property prices of what they end up owning will be significantly less than what they went into debt to buy.

Potential investors will be looking at more expensive home loans and may do well to focus on making careful real estate investments on smaller properties and high-density housing such as apartments, townhouses or units along with the rise of mortgage rates in Australia.

Acting with Prudence

The five consecutive monthly increases in the cash rate by RBA are not the end yet and are expected to continue further in the year.

The good news however, is that the economy and housing industry is still relatively stable compared to many other countries, even with consumers facing inflationary pressure not seen in a long time. Another upside is unemployment rates being at a record low, meaning there are sufficient jobs available for Australians, making loan repayment more likely, although it may come with compromises on personal spending.

For property investors, the best housing market approach is strategically investing in smaller properties with lower values. Doing so will mean lower mortgage loans, making ownership possible, even for first-home buyers. Investors should, however, actively monitor interest rates and inflation for the time to come to proactively make any changes to their future investment decisions.

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