A recent article written by Duncan Hughes (Australian Financial Review) helps to articulate why now is a great time for borrowers to review their finances so they’re ready when interest rates rise.
Many households may not be aware of the fact that over the past 12 months loan interest rates have jumped significantly. Owner-occupier borrowers are now paying between 30 and 40 basis points more and rates on interest-only and investor loans are up by 70 to 150 basis points, according to consultancy Digital Finance Analytics (DFA). Rates are expected to continue rising even if low inflation means an official rate hike from the Reserve Bank of Australia is unlikely in the near term.
If anything, the recent benign inflation data gives households some breathing space in which to pay off debt before rates do rise. As such now is a very good time for borrowers to review their finances so they’re ready for when rates turn.
Wealthy feel the pinch
Hughes states that “affluent households – with two incomes and combined annual salaries totalling more than $150,000 – are increasingly facing financial distress because they have taken out large loans with small deposits to pay huge asking prices for real estate hotspots like Melbourne and Sydney”
This is quite important as it means that in a rising interest rate environment, households have little wriggle room. Whilst many of these households will be holding paper profits in property which has risen significantly in recent years, it does not help with servicing ongoing debt.
Financial distress among property buyers has increased by 10 per cent over the last 12 months despite the lowest cash rates on record, according to Consumer Action, a federal government-sponsored financial counselling centre.
Property buyers say rising mortgage payments are the chief reason the family budget can’t cover all expenses.
Consumer Action claims the numbers being counselled are an “iceberg tip” of families around the nation struggling with high costs of living, underemployment, flat incomes and rising mortgage costs. The RBA estimates household debt has blown out to nearly twice annual incomes.
Toughest conditions in 30 years
Hughes writes that households are on notice that they could face some of the toughest borrowing conditions in nearly 30 years if interest rates rise 200 basis points, or eight typical rate hikes, as floated by the Reserve Bank of Australia earlier this month.
“Record low interest rates have made it possible for households to service much larger mortgages as they’ve chased rising house prices,” says Brendan Coates, a research fellow with the Grattan Institute, an independent think tank.
“Even a relatively small rise in interest rates paid by households would crimp their spending. Our research shows that if interest rates rise by just two percentage points, mortgage payments on a new home will take up more of a household’s income than at any time since the late 1980s.”
A 200 basis point rise would push the headline rate for interest rates to about 7.25 per cent.
The impact on family budgets would be equivalent to a rate of 17 per cent, the highest since Bob Hawke was prime minister.
In 1989 the Australian economy was turning from boom to bust in the wake of a global turndown and local lending excesses after deregulation of the financial sector. It was immortalised by then-Treasurer Paul Keating’s quip about a “recession we had to have” and subsequent mortgage defaults, bankruptcies and a stalled property market.
Back then the median house prices in Sydney was about $170,000 and average weekly wages around $500. Since then house prices have increased by more than six times whilst salaries have increased by 2.5 times.
The Grattan Institute’s warning follows the RBA’s signal that the cash rate (at which it lends to commercial banks) could rise by 200 basis points to 3.5 per cent.
“With interest rates across the globe at historic lows, the risk of an interest rate rise is real,” says Coates. “And because wages are not rising fast, households are burdened by big interest payments for much longer.
“While the RBA would lift interest rates cautiously, another disruption to international financial markets like 2008 could sharply increase banks’ funding costs, raising mortgage rates.”
To access the full article by Malcolm Hughes (AFR) please open the attached link here
Conclusion
With high household borrowing levels and major banks increasing their lending rates, it is important to review your debt position regularly. This will ensure you have the optimal structure in place and help minimise your borrowing costs.
If you are looking to access our mortgage solutions service for assistance with strategies to own your home faster, using debt to help build wealth or any other general debt advice, please contact Calibre Private Wealth Advisers on 03 9824 2777 or email enquiries@calibrepw.com.au
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