Property and lower interest rates – what you need to know
When interest rates fall, thoughts turn immediately to home ownership. First home buyers decide that it’s time to get into the market. Upgraders seize the chance to list their homes in order to move up. Investors begin to think that it’s time they started to plan for their retirements and start a property portfolio. And it can make sense, as long as a few basic rules are kept in mind. Here are some things to think about for each group.
First home buyers
Home ownership has long been touted as the Great Australian Dream and it seems that, no sooner do young people get a job or start a career, everyone in their world begins to ask them when they will be buying their first home.
Home ownership can have its merits – property is a growth asset, which has no capital gains tax if it is your principal place of residence. This means that it can perform less well than other assets and still deliver a greater return upon sale, as there is no capital gains tax to pay. But there is more to think about than tax and a low interest rate, such as:
- Is the loan repayment on the property you like higher than the rent on a similar property? Many areas have exceptionally low rent in relation to the property value, and in capital cities it can be as low as 3% and less. Under such circumstances, renting may be the cheaper option, as long as you plough the extra funds you now have into an alternative investment or a rental property elsewhere.
- Do you plan to live there for the long term? Buying and selling costs can make up 5 – 7% of purchase price, and unless you plan to stay, you can quickly get behind through buying and selling.
- Is the mortgage affordable if the interest rate increases? Rates are low now, but history tells us they will rise at some point – can you afford two, three or even four percent higher? Do the sums and factor it in to your budget to be sure that you won’t be facing a mortgagee sale at some time in the future.
Low rates will not only bring more buyers and investors into the market and make it easier to sell your current home, it will also make that next step up more affordable to you. In addition to the considerations listed above for first time buyers, upgraders must consider:
- Would a loan to renovate your current home, when added to your existing mortgage, be more affordable than upgrading? Keeping your own home and adding on means no stamp duty or buying and selling costs to pay.
- When rates go up, the new home, which likely has a bigger mortgage than the one you moved from, will cost proportionately more again. Can you afford this?
- Will there be added costs when you move? For example, are you further from work and will the costs of commuting or other related costs rise?
Investors are notorious for basing their decision around investing in property on the interest rate of the day. When rates go down, more investors jump in without even considering the dos and don’ts of property investing. If you’re attracted to investing right now because of the low rate environment, do remember:
- Investing in property is a business, not a hobby. Before doing so, you must get as much education under your belt as you can.
- Whatever you know about property from having lived in one doesn’t apply when you invest. And so, the house down the road or that lovely resort apartment should not be considered.
- When rates go up, you may or may not be able to raise your rents to cover the increase. This is because rents and interest rates do not usually move together – the movement on rent depends on the micro economics of the area where the property is. If you cannot raise rents, you will bear the rate rise alone. You will get an increased tax deduction, but 70% of that interest rate rise must be met by you.
The key for all groups is planning. Sit down and list all of the possible risks, and formulate the mitigants you will use if they eventuate. Nothing beats a well thought out plan, and where your finances are concerned, being sure you can manage a significant interest rate rise is crucial when it comes to buying an asset as illiquid as property.