What will it mean for property owners?
With interest rate rises seemingly imminent thanks to a strong property market and improving economic conditions, this week’s Property Pulse looks at what this will mean for the average home owner.
Although interest rates remained on hold this week, it is becoming increasingly apparent that the next move in rates is almost certain to be an upwards one. In fact, many economists are predicting an official rate rise as early as next month. The futures market is pricing in an increase of more than 2% in the official cash rate over the next 18 months. For home owners, it is imperative to budget for the impact these interest rate rises will have on the monthly budget and to start allowing for these likely increases.
Across the country the average variable home loan sits at 5.75%pa. The recent futures market yield curve shows that the cash rate is expected to reach 5.23% by February 2011 from a current rate of 3.0%. Should this occur and the differential between the cash rate and interest rates remains at the same level as it is currently it will result in interest rates sitting at 7.98%. This 7.98% is a similar level to the 8.05% interest rates witnessed between November 2006 and July 2007.
The most recent housing finance commitments data release from the ABS (June 2009) shows that during that month the average first home buyer loan size was $270,200. Whilst the average home loan size for a non first home buyer was $262,100. If we assume that these figures remain constant and we apply the forecast interest rates based on a 30 year home loan there are some very interesting results.
Based on the current average first home buyer loan size ($270,200) and the standard variable interest rate sitting at 5.75%, the average first home owner with a 30 year loan is paying $1,577/month ($394/week) on their home loan. By the time February 2011 comes and if interest rates get as high as the levels anticipated by the financial markets (7.98%), the same first home buyer would be paying $1,978/month or an additional $100/week. For the non first home buyer with an average home loan ($262,100) their home loan is costing them $1,530/month ($383/week). By February 2011 the same home owner would be paying $1,919/month ($480/week) or an additional $97/week.
On a state-by state basis, first home buyers in Western Australia have the greatest average loan size at $293,100, whilst first home buyers in Tasmania have recorded the lowest average home loan size at $187,700. Meanwhile, the largest average non first home buyer loans are currently found in New South Wales ($284,400) and the cheapest loans are within Tasmania ($173,800). Interestingly, in all states except for New South Wales, the average first home buyer loan size is actually greater than the average non first home buyer loan.
Based on the same parameters as the previous analysis, home owners will be required to find significantly more money each month as interest rates increase. If the financial markets expectations come to fruition, by February 2011 first home buyers will need to find between an additional $70/week and $109/week. At the same time those non first home buyers will be paying an additional $65/week up to as much as an additional $106/week.
In recent months we have seen the number of finance commitments for fixed rate loans jump, they accounted for 8 percent of all loans during June 2009. This shows that some are choosing to account for the potential future increases in interest rates by fixing their loan. The best opportunity to lock in at a competitive rate appears to have passed as most banks have increased their fixed rate loans during the last two months. Evidence suggests that over the long term home owners pay less on a variable loan however fixed rate loans have their place for those seeking certainty of what they have to pay each month.
These results highlight the importance of budgeting whenever investing in the property market as well as factoring in interest rate increases if you chose a variable loan. Alternatively purchasers can choose to fix their rate but they will pay over and above the standard variable rate for the convenience.
While everyone’s situation is different, it is important to factor in changes in interest rates and do whatever you can to ensure that you can manage when they do inevitably change. The interest rate increases may not sound that significant but having to find upwards of an additional $100/week in the budget can be a lot harder than it sounds, so account for this very real possibility from the outset.
