An increase in the official cash rate by the Reserve Bank of Australia (RBA) has caused concern across Australia’s lending and property landscapes. The ratcheting up of the rate has resulted in headlines proclaiming that blown-out loan servicing costs and reduced borrowing limits spell Armageddon for property prices.
While I recognise the need to attract eyeballs in this competitive media environment, it’s time to add some calm perspective to the discussion. Yes, interest rate increases have impacted property markets, but based on my years of experience, what’s happening now was to be expected, and is an entirely normal cyclical event.
Fortunately, there are also strategies to help borrowers mitigate the stress and impost of rising interest rates.
What’s happened so far
Let’s have a quick look at how we got to where we are.
As the pandemic set in, central banks around the world looked to stimulate their economies to offset the economic detriments from business shutdowns, shipping challenges and border closures.
The Australian cash rate was already low at 0.75% as at January 2020, but the RBA still wanted to act in the national interest. It culminated in the rate being reduced to just 0.1% by November 2020, which was a record low of historic proportions.
And there is stayed for the next 19 months helping cushion us against the worst of COVID’s financial fallout.
But the recovery was swift and sudden – it even caught the RBA off guard given they’d previously claimed rates weren’t likely to rise until 2024.
However, stronger than expected inflation saw the RBA act sooner. The central bank’s remit is to help keep inflation in the 2% to 3% band, so when it climbed past 5% in March 2022, they had to act.
An initial increase of 0.25% to the cash rate in May was followed by 0.5% rises each month, until two consecutive 0.25% increases in October and November which signalled a more cautious approach to increases.
So, as at today, we have the cash rate of 2.85%. That’s a 2.75% increase in just seven months, which has basically doubled everyone’s repayments – whether it be interest only or principal & interest – in the space of 6 months.
Sound scarry? Perhaps on the face of it, but let’s dig a bit deeper.
What we’re dealing with at present is short-term anxiety to an entirely normal long-term interest rate cycle. Anyone who is looking to hold their property for more than six months should consider this period as perhaps challenging but necessary.
This year’s interest rate rises have been frightening for most Aussie borrowers because they hadn’t seen an increase in 11 years. That’s a long time for a population to get used to low interest rates.
In fact, anyone who borrowed money within the last decade has never had to deal with a rate increase. Complacency around low interest rates was set in, so when they began to go up, all hell broke loose.
But over the decades, Australia’s interest rate has swung up and down. In the early 1990s we were tracking at double digits, and since 1997 we’ve been fluctuating around the 5% mark.
But some of the commentary I’ve seen recently has been so alarmist as to be, frankly, ridiculous.
First up, at 2.85%, the cash rate is back to where it was in about May 2013. That’s recent history in the grand scheme of property price and interest rate cycles.
Yet we’ve still seen economists predicting house price falls of around 20%, with some of the more hysterical commentators claiming a 30% to 40% drop is on the cards.
I say, be careful of economic opinions in this instance. Some of these same people were suggesting a 40% fall in property prices would occur during the pandemic… instead, we saw record price growth!
A wise man once said to me “Economists are right about half the time,” and I’d say that observation has held up well since the start of 2020.
So, have rising rates impacted property prices and purchasing activity? Of course they have.
A 2.75% increase in interest rates means people’s borrowing capacity is reduced. The banking regulator also directed lenders to implement a 3% buffer rate on loan applications. This means borrowers have needed to show they can make repayments on a loan at 7% to 8% before they’re approved for any funds.
Mind you, this should give us some cause for confidence, because these rules mean most recently approved borrowers are easily able to absorb the latest rate rises. As such there’s less chance of loan defaults and forced sales, despite the rate rises. I also believe the buffer rate will need to be reduced back down to its previous 2.5% soon, otherwise lenders will find their business grinding to a slow halt.
What can borrowers do?
So, we are in a normal rising rate cycle at present, but that’s still stressful for some borrowers. What can you do to overcome these near-term increases and enjoy the long-term benefits of borrowing to buy property?
Firstly, seek immediate advice from experienced mortgage brokers like us. We can discuss your individual circumstances and see where changes will bring relief. Many of our clients are surprised to learn there are strategies and products that can save them money and offset interest rate anxiety.
Also, many borrowers don’t seem to realise financial institutions are still aggressively looking for business. They can’t make a profit if they don’t lend out money. A chat with our brokers will reveal there are some excellent rates, loan conditions and cashback incentives available at present.
Next, utilise loan offset accounts. By parking savings in your loan offset, you can dramatically decrease your interest bill. Given Aussies managed to squirrel away record savings during the pandemic, there should be plenty out there with a buffer to park in their offset.
Another strategy is to gear your repayments as if you were servicing your loan at 7.5% interest. This will help you get ahead in your loan servicing, and build a buffer of funds in your account. You may need to do some work on the family budget, but for most it’s doable given banks approved loans with that sort of buffer level anyway.
And for those on a fixed rate, what can these borrowers do?
My final piece of advice is for anyone who’s been sitting on a low fixed interest rate over the past two years. As these rate periods expire, your repayments will rise, so must have tactics in place prior to this critical date. Don’t put off doing something in the false belief everything will be OK. Instead, talk to our experienced brokers who can help you prepare for the day you flip from fixed to variable.
Our recommendation is start making your repayments now at the higher figure so you get used to making those repayments, build in a buffer on the loan and protect yourself from that “interest rate shock” when your low fixed rate finally comes due.
Like most things, interest rates will ebb and flow as part of a normal cyclical process. The key to dealing with them is to adopt a long-term mindset and draw on the guidance of your specialist mortgage broking professional at Intuitive Finance.
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