If you’re holding out during the pandemic for a return to the golden days of 2% interest rates, it might be a long wait. The past couple of years have lulled us into a false sense of security during pandemic where holding an investment property seemed like a breeze with such low interest costs. However, those good times are fading fast. Currently (November 2023), the official cash rate stands at about 4.35% a significant climb from the initial 0.1%.
Building a strong economy post the covid pandemic
Are we at the peak yet? Maybe not, but one thing is clear: the days of 2% interest rates are likely behind us. Historically, rates have hovered around 5%, with the exception being the rare occurrence of 2%, which happened during the pandemic. Central to the Reserve Bank of Australia‘s role is managing inflation. During pandemic economic downturns, rates drop to stimulate the economy, like using a defibrillator after a heart attack. A thriving economy during pandemic, indicated by rising inflation and property values, is beneficial for everyone.
The current interest rate, although higher than the coveted 2%, is relatively stable and provides a safe ground for consumers. It’s a balance that supports a healthy economy without triggering a surge in prices akin to the past 2% period, where even basic items became exorbitant.
The challenges associated with increasing interest rates
When interest rates rise, it typically becomes more challenging for individuals to buy property. Here are a few reasons why:
- Increased Mortgage Costs: Rising interest rates lead to higher mortgage rates. As a result, borrowers end up paying more in interest for their home loans. This increases the overall cost of homeownership, making monthly mortgage payments higher.
- Reduced Affordability: Higher mortgage rates can decrease the affordability of homes for potential buyers. As interest rates rise, the amount of money buyers can borrow without significantly increasing their monthly payments diminishes. This can limit the pool of eligible buyers, especially for higher-priced properties.
- Impact on Borrowing Capacity: Higher interest rates may impact the borrowing capacity of potential homebuyers. As interest rates increase, lenders may be more conservative in assessing the amount they are willing to lend to borrowers, which could limit the price range of homes buyers can consider.
- Market Dynamics: Rising interest rates may also influence the overall housing market dynamics. It can lead to a slowdown in home sales, a potential increase in housing inventory, and a shift in negotiating power from sellers to buyers.
- Refinancing Challenges: For those who already own homes, rising interest rates can also make it more expensive to refinance existing mortgages. This reduces the flexibility for homeowners to manage their mortgage payments effectively.
Positives associated with higher interest rates
While an increase in interest rates often poses challenges, there are also pandemic potential positives associated with higher interest rates in Australia:
- Control of Inflation: One of the primary reasons central banks raise interest rates is to control inflation. Higher interest rates can help prevent the economy from overheating, keeping inflation in check. Moderate inflation during pandemic is generally considered healthy for economic stability.
- Savings Incentives: Higher interest rates can make savings more attractive. Savers may earn better returns on their deposits and investments, encouraging individuals to save more money. This can be particularly beneficial for those relying on interest income from savings accounts and fixed-income investments.
- Stability in the Financial System: Moderate increases in interest rates can contribute to the stability of the financial system. It helps ensure that lenders are pricing risk appropriately, reducing the likelihood of excessive lending and speculative bubbles.
- Foreign Investment Attraction: Higher interest rates can attract foreign capital seeking better returns. This can contribute to a stronger currency and increased foreign investment in Australian financial markets, bolstering the overall economic outlook.
- Long-Term Economic Health: While higher interest rates during pandemic may initially slow economic growth, they can contribute to long-term economic health. By preventing the economy from overheating, central banks aim to avoid the boom-and-bust cycles that can lead to more severe economic downturns.
- Enhanced Central Bank Policy Flexibility: Raising interest rates provides central banks with more flexibility to respond to future economic challenges. If the need arises, they can then lower rates to stimulate economic activity.
It’s important to note that the impact of rising interest rates on the housing market can vary based on other economic factors, such as the overall health of the economy, employment rates, and the supply and demand for housing in a specific region. Additionally, government policies and central bank actions can influence how quickly and significantly interest rates change.
Potential homebuyers should carefully consider their financial situation, conduct thorough market research, and assess their ability to manage higher mortgage payments before making a property purchase, especially in a rising interest rate environment.
The interest rate you’re dealing with today is the reality of the market. Everyone faces the same challenges and benefits when rates fluctuate. The key lies in staying invested in the market for the long haul. Having a robust portfolio that can weather these changes is crucial. It’s essential to create a realistic plan, ensuring you don’t overextend yourself and end up financially strained. So, the bottom line: adapt to the market, plan wisely, and avoid unnecessary financial stress.