Will they or won’t they?

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Will the banks lift rates or won’t they? If they do, how much will they go up by? Will the banks act independently of the RBA? Should I fix or should I stay?

OMG I have so many questions!

The RBA announced on Tuesday that the cash rate will remain unchanged at 1.5 per cent. Great, so why all the media warnings about interest rates going up? ‘Mortgage Warning: 8 per cent is the new 17 percent’

Interest rate shock is a terrible thing to have to live with as a home owner or a investor. Being on the edge of your seat each month wondering whether the monthly repayment on your home or investment property or both is about to head north is not a great feeling. I sympathise with people in this predicament, particularly given that the days when the RBA announced its decision and you could bank (ironically) on the lenders to follow are pretty much gone. This is why it’s crucial to make sure you can afford the repayments for your property loan if rates do go up.

The inability to meet loan repayments (mortgage stress) is the number one reason people put their investment property on the market. If they’re lucky they’ll come away with a nice profit but if they’re not lucky they can come away with nothing to show for their investment.

If 8 per cent is the new normal as the article above suggests, we will see scores of investors experiencing severe mortgage stress which will result in many having little or no choice but to put their property up for sale. Those who invested in a property recently (particularly Sydney and Melbourne) thinking rates will hover around current levels and won’t go up will be at the greatest risk. Those who did their cashflow modelling based on interest rates of 6%+ and who have invested in a high demand suburb where good tenants are plentiful will be much better able to ride out an interest rate storm.

Wages growth is at historic lows, the cost of living is forever rising, when you consider how much of your take home pay goes toward loan repayments, a rise in interest rates means at some point, something in your budget will have to give. What will you forego, will it be the mortgage repayment on your home, food, kids school fees, petrol in your cars, or the loan repayment on your investment property?

‘…one 25 basis point rate rise wiped out just 0.6 per cent of someone’s income nearly three decades ago (costing $156 a year or $13 a month), that figure is closer to a whole per cent today ($684 or $57). Four of them would now add $2760 to the typical annual repayment, and suck up 3.5 per cent of income (versus 2.4 per cent in the ’80s/’90s).’

This was the choice faced by many post-GFC, only then the culprit wasn’t high interest rates, it was economic downturn. The similarities between then and now are that pre- GFC the property market was booming and investors were elbowing one another out of the way to buy investment property. They bought at the peak of the market, they over-extended, they failed to take precautions with cashflow modelling and when the proverbial hit the fan in 2008 the offloading of properties began in earnest desperation.

Be sure to learn the valuable lessons from history. If you’re in the process of buying an investment property now and you’re not crunching your numbers based on a 7 or 8 per cent interest rate then you’re asking for trouble. Be smart with your property choice, be conservative with your numbers. Work on a worst case scenario, not a best case scenario.

Jon Ilievski – Head of Investor Education