How Do Rising Interest Rates Impact Your Borrowing Capacity?

Rising interest rates have struck again.

For the sixth time in as many months, the RBA has raised rates, throwing homeowners and potential buyers alike into a frenzy. The latest rate rise brings the tally of rate rises in 2022 to 2.5%.

These consecutive rate rises have significantly increased mortgage repayments over the past six months, which may come as a shock for many homeowners whom have not experienced a rate increase for 12 years.

The following graph illustrates the jump in monthly repayments that many have experienced over the past six months.

What does this mean for you?

If you are looking at your home loan and freaking out at where rates are heading, the end is in sight. We need to understand that we are looking at potentially another 0.5-1% rate increase before rates stabilise and potentially reduce towards the end of 2023/start of 2024.

What does buyers being re-rated mean? And how does buyers being re-rated affect property prices?

Australians are reacting as they start to pull their belts a little tighter, this coupled with buyers continuously being re-rated is having an effect on the property markets, as many are sitting on the sidelines with the uncertainty surrounding interest rates.

The bank re-rates customers each month based on the current interest rates. They apply an affordability test and affectively do a stress test to see how your budget/ cashflow can handle additional interest rate rises.

As we have seen over the past six months, interest rates have increased by 2.5% which means mortgage repayments have increased. This will affect how much debt an individual or family can take on, as a larger proportion of their household income will be consumed by mortgage repayments.

Therefore, not only are we seeing a reduction on how much Australians can borrow, we are also seeing property “buying pools” reducing.

E.g. In March 2022, there were more people that could afford to borrow $1m and pay for a $1.5m home.

However, with six consecutive interest rate hikes these people can only borrow $780,000.

This shrinks the amount of buyers a vendor (or seller of a property) has to compete for their property.

We are seeing auction clearance rates falling, time on market increasing, with less qualified buyers ensuring that some vendors are taking discounts on current listed prices.

It has been interesting to hear over the past few months local real estate agents talk about their experiences with vendors (people selling their homes) and trying to manage their expectations by using recent property sale data. We have explained to many agents that you need to focus on the big picture and articulate why the buying pool is shrinking and the affect this is having on prices.

The following graph highlights the impact that rising interest rates are having on people’s borrowing capacity, which has had a flow on effect to property prices.

As illustrated, someone that qualified for a maximum loan of $1m in March 2022 will now only qualify for a maximum loan of $780,000. That is a drop of 22%.

This is a significant decrease in people’s borrowing capacity in a short space of time.

With interest rates set to increase over the next few months, we can expect people’s borrowing capacity to continue to decrease.

Opportunity

With many experts expecting further property price falls in the months to come, there will be plenty of opportunities arise for those that have their financial plan and investment strategy in place. These opportunities are set to continue in the coming months as many house holds start to feel the pain of consecutive interest rate rises.

We need to be prepared

For many it may be the first time you have needed to tighten the belt, for others your foundations are set and it is a matter of pulling the different levers in place.

However, for the past six-eight months we have been supporting our clients with:

reviewing your mortgage
getting valuations if you are looking to invest
refinancing and considering fixing a proportion of your loan (leaving the amount you will repay over the next 2-3 years as variable)
reviewing your budget
analysing your spending and for some looking to reduce from 70-80% down to 40-50%.
establishing a buffer or emergency account
having a buffer in your offset account
reviewing your personal insurances, to ensure if you are injured, ill or pass, your family are still financially secure

In addition, the other main consideration we are currently supporting with is blocking out the white noise.

News outlets are there to sell and have a habitat of selling FEAR.

Our role is to support our clients in their financial behaviours and really take the emotion out of financial decisions.

As you don’t want to be using short term metrics to make long term decisions.