Who will be hit hardest as interest rates rise?
Economists and market observers have been warning of potential interest rate rises long before the Reserve Bank of Australia (RBA) actually lifted it on the 3rd of May 2022.
Mind you, Australia has not seen any interest rate increase since November 2010. That’s almost 12 years of ultra-low rates that gave many sectors access to cheap money.
While media reports paint an almost doom and gloom scenario as more interest rate increases are expected in the coming months, one thing to remember is that Australia has one of the lowest interest rate environments at the moment.
The May 2022 increase came from a low 0.1% to 0.35% -- still a negligible rise compared to the 1980s when rates were around 13-14%. At that time, Australian mortgage holders were paying sky high rates of around 16-17%.
So, it is worth putting things into perspective. Even if some economists are predicting the cash rate to hit 2.5% later this year or next year, we are nowhere near the ultra-high levels seen 40 years ago.
In his statement after the rate increase announcement, RBA Governor Phillip Lowe said the rate rise is “good news” because it reflects the underlying resilience of the Australian economy.
Given the rising inflation, it is still relevant to ask who will be hardest hit by the expected rate increases?
In his most recent Property Market Predictions, Wealthi co-founder Peter Esho pointed out who will be most vulnerable to interest rate rises.
He said, “Certain segments where people have borrowed too much money to buy McMansions (large homes in outer suburbs) will see a big correction. Places in Western Sydney like Oran Park, The Ponds, Bella Vista and Castle Hill are vulnerable because high price growth has been fueled by cheap debt and little income growth.”
“If you have a large mortgage, it’s time to think about interest rates rising by around 1-1.5% in the next couple of years. If you’re an owner occupier with too much debt and little income security, or work/business isn’t doing well, it’s time to think about a plan B.”
Some property research companies agree that home buyers who bought in the past year were expected to feel the biggest impact of rate rises as they probably took large mortgages to pay for lofty house prices.
On the other hand, property investors will be in a better position to deal with interest rate increases. As Peter pointed out, “But if your mortgage is against an investment property, you’ll be OK because rents are likely to rise. Pick a good property manager. The market will slow down in the next few months, but if you have the opportunity to buy or grow your portfolio, this will be a great opportunity.”
So while the headlines lend to a blanket of fear and worry for mortgage owners, there is clear divide that separates those with huge mortgage bills but not a lot of income for repayment and those with investment properties that generate ongoing rental income.
As a property investor, you may be in a better position to manage any rate increase as potential rent increases will provide a cushioning effect. And while wage increases are not a given in the current environment, property investors with extra sources of income have much bigger buffer.
This means they could be more resilient and better equipped to deal with the rate rises.
As a word of reason, Peter said, “Real estate slowdowns usually last about 1-2 years, we’re probably 3-6 months into this one. So, spend the rest of the year finding opportunity while everyone else is in panic mode.”
If you would like to discuss the Australian property market in more detail, please reach out to the team to organise a time to have a conversation about how Wealthi can help you build a successful property portfolio.