Its all connected! Property prices and interest rates; Intrinsically linked.
by Ross Greenwood
Right now, most people who own assets like houses or investment properties should be happy. House prices up; superannuation up; share prices have been at record levels. All good, right?
- YES (mainly)
For the most part, yes! The increase in property prices is directly related to falling interest rates and easy access to debt. And you need to understand there is a direct relationship between interest rates and the value of just about everything. Broadly, if interest rates go down, home/asset prices go up. Conversely, if interest rates go up (generally) asset prices go down. It seems obvious, but it’s good to keep in mind.
- LETS DO THE MATH
To understand, think of buying a house. If your income can afford a million-dollar property with interest rates at 5 percent; you can afford a whole lot more house if interest rates drop to 2 percent … so people competing at auctions can afford to pay more … and do. The result: house prices go up.
The same is true for share prices, indeed all asset prices.
Another way to think about this is a 5-year term deposit of $1,000 that pays you 5% interest, or $50 a year. If general interest rates drop to 2%, a new person taking out that term deposit would only get $20 a year. That, technically, makes your investment more valuable because it gives a higher return … but it diminishes because eventually the 5-year term expires.
So that quickly explains the relationship between property prices and interest rates. But when it comes to buying a house or an investment property, there’s something else: your wage.
- YOUR WAGE
A person who knows their income is going to rise quickly in the future is likely to pay more for a house (any asset you could say) than a person who is uncertain about their income (or someone who is older, in their late 50s, say … who might be coming to the end of their working life). This is where individual circumstances dictate any persons’ decision about what to invest in or how much money there are prepared to borrow (or, indeed, how much a bank is prepared to lend them).
Which brings us to affordability. What you can afford – when buying a house or an investment property – is a combination of factors: the price of the house; the interest rate you can afford to pay and your future income.
If any of these factors move, your ability to afford the house changes. If the price rises, it is less affordable; if interest rates go up, less affordable; if your income goes up, more affordable.
So, with house prices and other assets at record prices right now, their affordability still depends on interest rates remaining low for a long time (and given the current state of our economy, that may well happen). But to be confident about any purchase decision now … if you are borrowing money … you need to be also confident about your ability to earn consistently into the future.
Don’t forget – Though rates are expected to remain low for the foreseeable future, banks will always assess you as though interest rates do go up.
ONE LAST THING
And one final thought. This is not just about you. Remember that it’s a responsive market-place; in order for someone to buy your house – or any other asset – for more than what you paid for it, they also must be confident they can afford it, both now and in the future.
Does your property interest rate have you in the right position?
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