On Tuesday, the Reserve Bank raised interest rates for the first time in 11 years, and interest rates are expected to rise sharply for the rest of 2022.
we have House price growth has already slowed It all started with buyers’ expectations for rising interest rates. But what does higher interest rates mean for the housing market?
Pricing in the futures market means that cash rates will exceed 2.5% at the end of this year. This means that the cash rate will increase by more than 2.2 percentage points.
If the mortgage interest rate increases by the same amount, and it is entirely possible that the lender will increase further when trying to repair the net interest margin. This will double the average interest rate on new loans from the current 2.5% to 5%.
It’s a very rapid increase. It will soon bring mortgage rates back to levels not seen since almost 10 years in 2013.
The forecasts of major banks are more conservative. By the end of the year they put the cash rate somewhere between 1% and 1.5%.
If the mortgage rate rises by 1 percentage point, the total repayment amount will increase by about 12%. This is despite interest rates rising 40%. This is due to the characteristics of Australian fixed mortgages, where when interest rates rise, principal repayments actually decrease to new mortgages, offsetting the increase in interest payments. This feature is the main reason for the surge in savings in the form of principal payments after interest rates were lowered at the start of the pandemic.
This increase in savings mechanically reverses mortgages and cushions them from repayment shocks.
Borrowing capacity is also reduced. The maximum borrowing amount will decrease by about 10% as the mortgage interest rate rises by 1 percentage point and will increase to 19% if the interest rate is 2 percentage points higher.
This has a huge impact on the housing market.
In a recent Financial Stability Review, the RBA estimated that if mortgage rates rise by 2 percentage points, actual home prices will fall by 15 percent in two years.
The “real” part is important. This means that if inflation builds up to 5% over the next two years, price levels will be only 10% lower than they are today.
There is a considerable dip, but it only traces a small portion of the recent extraordinary profits we have seen across the country. With a 10% drop in nominal prices, domestic prices will be in the middle of last year. Prices in all capitals only revert to those seen at some point last year.
Interest rates are important for homes, but they are not the only driving force. RBA estimates separate the impact of interest rates on prices, but other things are important as well. Indeed, RBA raises interest rates when the economy and wage growth are strong.
These other factors push up home prices. Interest rates have risen twice in the past, and home prices have risen.
From 2002 to 2008, prices rose by more than 30 percent, despite a 3 percentage point increase in cash rates (due to data limitations, the graph starts in 2003). This is a good comparison with the current term, as interest rates have risen sharply and it was a time of significant wage increases expected this time.
From 2009 to 2011, home prices rose 11 percent at peak times and 6.6 percent at the end of the tightening phase, pushing interest rates up 1.75 percentage points.
Is it different this time?
In short: Yes – there are two related reasons.
First, since the pandemic began, home prices across the country have risen by 35%. This growth rate could not continue without rising interest rates.
Prices have risen as borrowing costs have fallen. This process is almost finished.
Second, in connection with the above, price growth has already slowed significantly nationwide. The fact that many buyers and sellers have received signals from recent market performance and growth has slowed significantly suggests that prices remain weak.
Therefore, the outlook for price increases is that prices will remain flat or fall slightly.
But much can change, both in terms of interest rate spikes and wage growth. At this point, both remain uncertain.