What is interest rates?
The interest rate is the amount a lender charges a borrower and is a percentage of the principal—the amount loaned. The interest rate on a loan is typically noted on an annual basis known as the annual percentage rate (APR).
The rising interest rates
Before we assess the reasons why central banks around the world have hiked interest rates, it is firstly necessary that we understand the essential components of the real estate market.
Most Australians finance their property purchases through mortgages – a sum of money borrowed and secured by the property itself. This means that if the property buyer cannot fulfill their commitments to repay the mortgage, the debt issuer has a legal claim on the property to recover the debt issued.
Mortgages are sensitive to interest rate adjustments under the discretion of the Reserve Bank of Australia. The current cash rate target is 1.35% in July which has increased by 0.50% over the past month. It is expected that the central bank will continue interest rate hikes until inflation is reduced to its target of 2-3% p.a from its current rate of 6.1% p.a.
Inflation is currently high due to a plethora of problems that are not inclusive of the following:
- War in Ukraine has increased energy prices globally
- Supply chain headwinds sustained from COVID lockdowns
- Mass government stimulus in response to COVID overly boosted consumer confidence
Therefore, interest rates have been increased as a response to inflation. This is to discourage consumer overspending and slow economic activity.
Effects of rising interest rates on the real estate market
Rising interest rates will discourage people from entering the real estate market. Current mortgage-owners will generally attempt to refinance into fixed-rate mortgages where possible or downsize in response to unsustainable increases in mortgage repayments. This is because their mortgage becomes more and more relatively unaffordable.
The median house price in Sydney could drop by $297,000 by the end of 2023 compared to the start of this year, to $1.12 million, according to NAB’s research.
Risks of rising interest rates
A decrease in demand for housing and an oversupply of houses hitting the market may cause a slowdown in the booming growth of the Sydney property market. Subsequently, as people downsize, demand for rental property may increase. The price of rent is speculated to increase.
Changes in the real estate market will influence the industry too. Real estate professionals may have to respond to this situation by finding methods to add value to their services or upskill their real estate qualifications to remain competitive.
However, in conclusion, it is notable that interest rates are only one factor that property buyers consider before making their decision. While market speculation is undoubtedly pessimistic, it is impossible to determine what will happen to the housing market in Australia. Property buyers should be encouraged to look at more than interest rates when entering the market.
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