When we discuss interest rates sometimes it’s easy to mistake its reach to just one market. It’s not just bond traders, share market investors, or property tycoons affected by interest rates. Rate changes affect ordinary home owners as much as anybody else.
If you happen to own a house, you are greatly affected by interest fluctuations. Why? Because a house is one of the biggest assets owned by average Australians. It contributes the majority of your net wealth. And what is it that banks always claim as collateral if you can’t pay your debts? That’s right, your house.
Around 67% of Australians own their own homes. This could mean that a rate hike could majorly affect the wealth of more than half of Australians.
Housing Supply and Demand
OK, so let’s keep this very general. When interest rates are low it encourages potential home buyers to enter the market. Why? If interest rates are low it makes it cheaper to borrow. Hence lower interest rates mean lower interest repayments.
We can then assume if lower interest rates attract potential home buyers to buy, the demand for property should increase. And if demand increases then so does the price.
It’s the old principal of supply and demand. But it doesn’t stay like this for long. As more and more buyers enter the market, property prices start to reach levels above and beyond. These highly inflated property prices put a lot of pressure on first home buyers.
The sheer value dwarfs the income and expectations of first home buyers. The market has becomes so over-inflated that first home buyers are forced to buy in rural areas. And the opposite of this situation hold up generally if interest rates are high.
If rates are high then interest rate payments are high. This will discourage potential buyers from taking out mortgages. That reduces the amount of buyers in the market, creating an oversupply of property. This oversupply will tend to repress or stagnate housing prices. However this does not necessarily make house more affordable.
It’s likely that you will either pay thousands more in interest payments. Or you will pay thousands more to acquire property. Just from this simple rule alone, it’s clear to see why you should care about a rate hike.
But again, what I’ve just stated is a generalisation of interest rates and property prices. There are situations where interest rates increased and housing prices follow in suit. Over a time period of 25 years (1956–1986) Canadian housing prices increased along with mortgage rates.
Source: CMHC, CREA, Stats Canada
Source: Bank of Canada Economic Research Branch
This is why I said before that the rule above is general. Interest rates and property prices do not exist in a vacuum. Both of these factors are influenced by a myriad of external forces.
Interest rates are primarily used by central banks to control inflation. If inflation is becoming too high then central bankers might decide to increase interest rates to keep prices in check. For property forces such as consumer confidence, income levels and level of employment play a huge role in determining prices.
And now that we have seen Canada break the interest rate property rule, let’s have a look at Australia. The two graphs below represent the Australian cash rate and real house prices.
Source: AMP Capital
It might look convincing that our reduced cash rate has spurred our property market. And while low interests did contribute, it may not be the entire picture. Low interest rates were a contributing factor the rise in real house prices. However it’s more likely that since the mid-2000s the Australian housing market was subjected to high demand due to population growth.
As shown by the graph below, house price growth peaked in the middle of 2000 and 2005. A reason for this astonishing climb could largely be because of exceeding demand. Demand created largely through population growth.
So while it may seem like a rate hike could be bad for the average residential owner, it might not be as bad as you think.
Junior Analyst, Money Morning
PS: Property is a great way to boost your income through rent or just old fashioned capital gains. However you can also do the same in the stock market. And instead of rent, just replace the word with dividend. The principle is pretty much the same.
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