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How will rate hikes affect house prices and mortgage repayments?

By ,| 4 min read

Home loan interest rates have risen after Reserve Bank of Australia (RBA) cash rate hikes. This decision was spurred by a need to slow inflation, but means that many borrowers are set to see their monthly repayments increase.

But increased interest rates can be good for first home buyers and property investors who are likely to experience lower property prices.

In this article, we’ll explain how interest rates impact house prices, your borrowing power and property investment.

The effects of the cash rate hikes

After the initial cash rate hike in May 2022, house prices fell by 0.11% in the same month. It may be a small decline, but it’s indicative of a likely future downward trend in Australian house prices – or at the very least much slower price growth.

Lower house prices don’t necessarily mean that owning a home will be more affordable. As home loan interest rates rise, your mortgage costs increase. So it depends on how much house prices drop and whether wage growth catches up.

However, one of the reasons for the RBA lifting the cash rate is to slow inflation and stimulate wage growth. This would encourage sustainable growth throughout the economy.

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Why would higher interest rates lower house prices?

When the cash rate increases, so do interest rates on home loans. We’ve already started to see banks and lenders pass on rate hikes in full to their customers.

Mortgages are a massive financial undertaking, and they become far less attractive with high interest rates attached.

Buyers may become more cautious and thoughtful about taking out loans and will spend more time thinking through their decision.

Currently, further cash rate hikes are likely and this creates more hesitation among buyers who are anticipating future rate rises.

Some people may no longer be able to afford to buy a home because of high interest rates. This will lower demand and competition, encouraging house prices to drop.

However, increased interest rates impact the various regions of the country differently. For example, property price growth has stagnated notably in Australia’s expensive capital cities (i.e. Sydney, Melbourne and Canberra). But, growth is still occurring in regional areas and less expensive cities like Adelaide and Brisbane.

Borrowing capacity is reduced

One side effect of higher interest rates is that buyer borrowing power declines. This happens because higher interest rates make a loan more expensive to service.

Your borrowing capacity is the loan amount that you are likely to be approved to borrow. Those with higher incomes, minimal debt and a good credit score are more likely to have a higher borrowing capacity.

It’s important for lenders to thoroughly assess a home loan applicant’s borrowing power to ensure that they will be able to afford their home loan repayments.

In addition to assessing your overall financial situation, lenders consider the Australian Prudential Regulation Authority’s (APRA) minimum interest rate buffer of 3.0%.

This helps banks figure out whether you would be able to afford your mortgage repayments should interest rates rise.

Some lenders have their own interest rate buffer or ‘floor’ that may exceed the minimum 3.0% set by APRA.

Auction clearance rates may drop

A consequence of higher interest rates is reduced borrowing power, meaning that buyers have less money to bid at auctions. This could lead to lower auction clearance rates, forcing sellers to consider lower offers on their home.

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The effect of low interest rates on the housing market

When interest rates are reduced, it is cheaper to borrow money. This means that obtaining a loan is often more accessible and appealing to prospective home buyers.

Some buyers choose to wait until there are favourable interest rates before looking to buy.

Naturally, this has a tendency to increase demand for housing as demand starts to outweigh the property supply.

Increased demand drives up house prices and buyers are sometimes forced to move quickly as properties are snapped up in no time.

Interest only home loans may increase

It’s common for property investment to rise during periods of lower interest rates. Part of the reason for this is that interest only (IO) mortgages become more attractive.

With an interest only home loan, the borrower only makes repayments on the interest that accrues on the loan, rather than paying off the loan itself. Conversely, principal and interest borrowers make repayments towards the principal (loan amount) as well as the interest.

Home loan interest is a fully deductible expense for property investors. So, if interest rates are low and an investor has an IO loan, their repayments are not only low – they are also tax deductible. This gives savvy investors more money to pursue other investments.

Want to find out your borrowing capacity or just learn more about your home loan options? Book a free appointment with a Lendi Home Loan Specialist today.

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.

Tags: home loan, first home buyer, new home, new purchase, loan repayment, mortgage repayment, repayments, property prices, interest only repayments, interest only, official cash rate, rba cash rate, cash rate

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