3 Reasons Why Interest Rates Could Soon Rise
If you were going to write an article that would scare a substantial portion of property investors and home owners, chances are it would start like this:
for a loan of $600,000, just a 2% increase on loan rates from 4% to 6% means having to find an extra $8700 a year in interest repayments. For a million dollar loan (the average in Sydney and Melbourne) that figure rises to $14,600 extra per year.
Interest rates are the cost of money. So if they rise, then the cost of borrowing to finance one or more properties also rises.
That part is simple.
What isn’t simple is predicting when interest rates will rise. But what we can do is figure out what might cause them to go up. That way, if you see certain headlines start to appear, you can refinance, lock in fixed rates or take other steps to ensure that your interest payments on your investments don’t go through the roof.
So what could cause rate rises?
Around a decade ago, the global financial crisis led to the Reserve Bank of Australia cutting interest rates aggressively and quickly. The reason they did this was to stimulate growth. By decreasing the cost of money, the hope was that businesses and consumers would be confident enough to spend and invest more. If that happened, then we could avoid a damaging recession, massive unemployment and wage deflation.
So the current low rates are the result of tough economic times. But the economy improved. Unemployment is low, business confidence is high and consumers are spending again on everything from new cars to renovations.
But interest rates are still at historically low “emergency” rates. That’s a little like a fire truck continuing to pump water onto a bushfire well after it has (probably) finished burning.
The simplest reason that interest rates could rise is because we are no longer in an emergency period, and the economy as a whole is stronger. Those two things usually means “normal” rates that are far higher than the 1.5% cash rate currently set by the Reserve Bank of Australia. For example, in 2007, the cash rate was 7%.
The scary part? Home loan and investment loan rates are always a few percentage points higher than the official cash rate – that’s how banks make those billion dollar profits.
Unlike Ireland, Spain, Portugal and the United States, Australia has never suffered a spectacular housing market crash. Our politicians and regulators would very much like to keep it that way. For most Australians, property is both the single largest asset and investment they own.
But to try and avoid a crash, sometimes Governments and regulators need to tap the brakes. And that is what the bank regulator, APRA, has been tasked with doing.
Most investor loans come from banks. If loans are easy to get, and are cheap to service, then more investors will likely try and access them. Loans can be made cheaper to service by making them “interest only” where repayments need only to cover the interest costs, not the principal amount. But this has led to much larger numbers of interest only loans being issued by banks to consumers than in the past.
APRA sees this as a risk, and has acted accordingly. It has introduced new limits on what percentage of banks total number of loans can be the riskier “interest only” kind. If you are an investor, that means refinancing your current loans might now not be possible on the generous interest only terms of the past. And that means an effective interest rate hike for your loan(s).
Australians are now more indebted than at any other time in history, and the Reserve Bank has noticed this fact. Debt build up magnifies the seriousness of economic downturns. If speculative housing price growth continues, especially in Sydney and Melbourne, and other measures don’t work, then the Reserve Bank is likely to consider modest interest rate hikes in order to prevent the build up of an asset bubble.
If the Reserve Bank raises the cash rate, then the major lenders would also raise their mortgage and investment loan rates. Remember, the rates banks charge for mortgages are always higher than the official cash rate.
As you can see, there are any number of reasons why the interest rates you pay on your home loan or investment loan might rise. If you see any of these things in the headlines, it might be an early warning sign that rate rises are coming, which will give you the opportunity to do something about it before it costs you thousands.