Two down, one to go?
While one interest rate rise is unlikely to slow the housing market down, a succession of rate rises certainly does. The Reserve Bank’s cash rate of 3% was simply too low to be sustainable, but it has taken most of this year before growth has returned to our housing markets. This is because it takes a while for borrowers to regain confidence but once they have got their confidence back, it takes a number of rate hikes to knock it out of them again.
As the graph shows, when the cash rate starts going up it keeps on going up until first home buyers are squeezed out of the market and this then gradually slows down growth in the market.
Because it takes a long time for this slowing down to become noticeable, the Reserve Bank sometimes overshoots the mark, sending interest rates to unsustainable levels. I certainly hope that the RBA will pause to assess the impact of its rate rises before deciding whether to raise the cash rate again in December.
Now is not the time to be reacting to a steady increase in housing prices by raising interest rates. They are a blunt edged tool that also affects all borrowers, flowing into higher rates on credit cards, personal loans and business loans. The economy is fragile and poised for a better than expected move back into solid growth. Increasing the cost of borrowed money puts all of this at risk.
Even so, those on variable mortgages should be prepared for a series of rises next year. Based on its past performance, as the graph shows, The RBA is likely to continue putting up rates if economic growth and inflationary pressures increase. The first pause is likely to happen when the cash rate reaches 4.5% to 5%. As the blue line indicates, this will still leave it well below most historical rates since 1990.
How do rate rises affect investors?
What should new investors watch for in the housing market? The answer is brutally simple – avoid those areas which have seen heavy first home buyer activity, as these are the areas most at risk if rates rise. Even a small increase in foreclosures can signify a large increase in listings, as disillusioned first home buyers bail out of the housing market.
For housing investors with existing properties, the impact of interest rate rises is not significant, provided they keep watch on rental demand and the cost of rentals in their areas. Higher interest rates make it far more difficult for first home buyers to enter the ownership market. As a result, increasing numbers of them are forced to remain frustrated renters. This increased demand for rentals enables investors to put up rents as leases expire and recoup their increased interest payments.
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