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Article | 5-minute read

Rising interest rates – is it time to refinance?

July 2022

Interest rates have gone up after a decade of record lows and more hikes are expected through to 2023. So what does that mean for the housing market? ANZ Research forecasts a decline, not collapse, in house prices, but it may be time to revisit your mortgage.

 

When the Reserve Bank of Australia (RBA) board increased Australia’s cash rate in May, it was the first cash rate rise in 11 years. The RBA is expected to continue with rate rises through 2022 and into early 2023 as it tries to rein in inflation.

Inflationary pressures have intensified in Australia. Reserve Bank Governor Philip Lowe told the ABC’s 7.30 program in June that inflation may peak at 7% by the end of year before easing in 2023. That figure is far above the RBA’s inflation target band of 2-3%.

Lowe confirmed in his ABC interview that the RBA will continue to lift interest rates. “I think it’s reasonable that the cash rate gets to 2.5% at some point,” he said.

ANZ forecasts1 that the cash rate will reach 2.6% in early 2023. That will motivate many consumers to seek out more competitive rates on their mortgages.

Higher interest rates will also affect the housing market, but ANZ Research predicts an easing rather than a collapse in house prices.

ANZ forecasts house prices to decrease by 5% in 2022 and 10% in 2023.2 This means housing prices would still be 6% above pre-pandemic levels at the end of 2023.

“We expect the housing descent to be an orderly one,” says ANZ Senior Economist Adelaide Timbrell. “We’re not expecting to see a recession in Australia or a housing price crash.”

“Households have really strong balance sheets and Australia has tighter lending rules than in previous years, which means that the average borrower is not that risky and has the savings, the employment opportunities and the income opportunities to continue to be able to pay their mortgages under higher interest rates.”

 

Interest rates on an upward trajectory

ANZ expects a steep increase in mortgage rates over the coming year. An expected cash rate of 2.6% by early 2023 would equate with variable mortgage rates reaching about 5%1 if the increases are passed on by lenders.

However, many households have been putting in more than the minimum repayment on their variable rate loans. This means about 40% of borrowers on a variable rate would not need to increase their payments until the official cash rate rose to 2.1% and variable rates went up commensurately.3

The relationship between fixed rate and variable rate mortgages is also normalising after a period of extraordinary monetary policy by the RBA.

During the pandemic, the RBA made short-term lending much cheaper. This flowed through to historically low fixed rate mortgages for consumers in 2020 and 2021. The RBA ceased this program in February.

The 40% of mortgage borrowers with fully fixed loans will face a jump in repayments when their fixed rate agreements expire but will save on interest payments until then.3

 

What rising interest rates mean for house prices

Factoring in interest rate rises, ANZ expects a decline of 5% in housing prices in 2022 and a further 10% drop in 2023. This means housing prices would still be 6% above pre-pandemic levels at the end of 2023.2

 

Australian median housing prices 2010-2023 (forecast)

Source: ANZ Research

 

Australian housing prices % change year-on-year 2019-2023 (forecast)

Sources: CoreLogic, ANZ Research

 

“Those rising interest rates will hit housing prices, but mostly through reduced borrowing capacity rather than widespread forced selling,” Timbrell says. “If people, on average, have less borrowing capacity, then there’s less money available to spend and that does drive down housing prices.”

This downward pressure on prices is a benefit for both first-home buyers and people wanting to sell their current home to upgrade. “Falling prices generally mean that you’re losing less when you sell your smaller home than you’ll save when you buy a larger home,” Timbrell explains.

 

Rents may increase

Timbrell points out that the increase in interest rates is not the main factor behind trends in rents for residential properties, as rents are driven by the balance of supply and demand. Demand has been supported by preferences for larger homes for remote workers, as well as employment growth which has encouraged some residents to “spread out” into more dwellings. Stronger population growth as immigration ramps up will also help.

“When the vacancy rate is low, renters have fewer options. That means they may be willing to pay more in order to secure that property. That’s really what we’re seeing in most capital cities at the moment,” she explains.

The rental market remains extraordinarily tight. SQM Research national vacancy rate data shows that in May this year rental vacancies were tracking below 1% in every capital city except Sydney (1.5%) and Melbourne (1.7%). A balanced rental market has about a 2.5% vacancy rate.

In Sydney, rents are up 17.5% over the past 12 months. Brisbane is up by 18.6% and Melbourne by 14.8%.

 

Housing is ripe for renovation

House building approvals have come back to their five-year average after a spike due to the government’s HomeBuilder subsidy in 2020-21. Renovation approvals are also strong. ANZ data shows spending on renovations in May was 15% above pre-COVID levels.3

Construction costs, however, have risen due to labour shortages, supply chain disruptions and other issues.

“It’s not the cheapest time to be renovating or building a property,” says Timbrell. “But also, we are in a situation where far more people are finding more value in renovating or building a property.

“People use their homes differently than before COVID. When you are working from home, you need more space per person than when you were at an office five days a week.”

“In Australia, when you are looking to find an extra bedroom, while renovating is expensive, it could actually be far cheaper than paying the stamp duty and difference in price to move to a new home.”

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  1. ANZ Senior Economist Adelaide Timbrell
  2. @ANZ_Research tweet,16 June 2022
  3. ANZ Research, Australia’s Housing: Orderly descent, 17 May 2022
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