The impact of increasing interest rates on property prices

{Note from mods - this thread split from here: The definitive Sydney 2022 Q1 and Q2 market analysis and conclusions}




The multi-bn liquidity drag on Aussie households, over 20% of the total stock of ALL mortgages across Australia swapped over permanently to P&I from IO inside an 18 month period. That is, as a macro share, 1/5 of mortgages faced a permanent increase in repayments in repayments. It was a structural change to the financial stability of household sector, adding resilience to it (which will help greatly in this next down cycle). We have rollovers daily from IO to P&I, but the total stock of outstanding mortgages being IO overall as a share will likely never have this adjustment again (as reference, imagine we BAN IO loans for everyone now and force everyone to swap within 18 months. IO rollovers was roughly equivalent to this).

The fact that it happened at the same time as the biggest fall in Sydney house prices in 30 years while rates stayed flat. While many 'overplayed' its importance and assumed house prices would tumble much further than it did, it was, and is, one of the biggest single reasons driving the above. It was also a big reason for 2 unexpected rate cuts in mid 2019. The drag it (and tightening lending conditions) had on economic activity slowed the economy much more than initially anticipated by regulators, and intervention kicked in to turn the debt cycle around again.

An increase in interest rates has a similar transmission mechanism, although significantly stronger. It doesn't just increase the savings rate (which is effectively what P&I loans), it actually increases the cost burden of households, reduces borrowing capacity greatly and impacts almost all mortgage holders over time.

The only upside here is that all macro measures of household resilience are quite strong for now. It's about to get a massive test.

Debt cycle ebbing and flowing again.

 

Sorry how do higher rates increase the savings rate?

Given the extra expense goes just to paying interest, i.e. dead money from a savings perspective, i would have thought it has the opposite effect.

 

I think in context he meant P&I actually pays the loan down ie forced savings?

 

Higher bank term deposits and savings rates.

 

Ok see the impact on deposit rates, but would suggest the avg aus household sensitivity to mortgage rates is far higher than to deposit rates. Also very age specific.

And switching from IO to P&I definitely helps savings rate, but the comment seemed to be about higher interest rates driving higher savings while on P&I. Pretty sure that isnt right. If i misread it, apologies.

 

Seems a bit of 'mongering' in media - clickbait

https://www.news.com.au/finance/eco...s/news-story/287d93ebcfc3a4afcf8efeb34778827a

Although, I'm slightly bearish mainly due to listening to too many US podcasts of doom and gloom lol, I think what a lot of the veterans on here have been saying is that they dont happen overnight for RE, more like in slow motion.

I'm now closer to being neutral, even with IR going over 2%
I dont think there will be a cliff or mass forced sales...

 

Maybe... but our RBA has been asleep at the wheel. What happens if next inflation number is over 7%?....then the following one is 9% plus....then it gets interesting. If we don't raise it...we have an issue with currency which will plummet.

Falling dollar means...you pay for more imported goods...dreaded cycle of inflation. Too many people have not idea......how this works.....anyway lets see how it works.

For the record...it will not affect me.... I have shored my position .... a lot is in liquid.....if you don't have access to cash...you will be gone....

 

Can always rely on News for good clickbait.

There are going to be a lot of interesting situations globally for housing markets. I do spend a fair bit of my time professionally looking at some of those markets. So many are now priced at levels completely inconsistent with where interest rates need to be to deal with the inflation problem. Its a very different problem to the GFC, where we had (in the US at least) terrible and irresponsible lending practices. It does lean itself towards the idea of a slower burn correction rather than crash.

As always however, the risk is that, through the rate hike phase, something breaks. By that i mean something in the economy sort of breaks that causes a sharper downturn, with unemployment spiking. That occurring at a time when the housing market is already under pressure due to severe unaffordability (just cause prices are consistent with rates far lower than were they have become), could cause a slow burn to become something more severe. Not saying it will, just a thought exercise.

 

Its not as simple as just targeting the inflation rate though, despite what it says on the tin.

It depends what unemployment is doing, what wages are doing, what rents are doing, how the broader economy is faring, and yes, even what house prices are doing.

I don't think they'll just blindly jack up interest rates for better or worse till the CPI numbers drop to the targeted band.

And for the record (and you can quote me 2 years from now), I still think the inflationary pressures are transient. If they were building pre COVID, I'd be a little more worried but by and large, CPI now has been manufactured by easy credit, cash splashes, opportunistic pricing and of course, facilitated by war.

And I think it will run out of steam in the short to medium term....def within 5 years, probably within 2, maybe even within 12 months.

I mean there was literally NOTHING pre COVID that was seeding inflation.

 

Yep see below...not an exact science....issue is will there be a another black swan which will have an impact. We are now $1trillion in debt...so large stimulus is not practical...lets see.

What happens if interest rates don't go up soon? The genie could come out of the bottle

 

If it takes 4-5 years to get inflation back within target, property investors are in for a rude shock.

I agree they wont blindly jack up rates until CPI is within band. They will of course monitor all the other factors you mention. However, that will primarily be done primarily to get a read on where CPI is going.

Put it this way, if the housing market completely tanks, the RBA probably holds off on further hikes for a while to see if that pushes inflation lower (and it should). But if for some reason CPI remains stubbornly above target, they will eventually have to continue raising rates. They simply wont have a choice. As a capital importer, the moment global markets lose confidence in our management of our currency, the game is up.

 

as @Lacrim mentioned, I meant that Interest rate changes are much more powerful and much more broad then the IO changes.

 

Good article for the layman to understand inflation and impacts..

'Get on with it': Why the surging cost of living means interest rates need to rise soon

 

This article also does a good job of explaining how inflation targeting and expectations matter, something that came up elsewhere here today.

 

Great idea to split this post!

 

It makes sense. At the peak of IO up to 40% of loans were IO in 2017.
Interest-only loan crackdown 'could lead to US-style meltdown'

The cash rate in 2017 was 1.5%. By November 2020 the cash rate had fallen to 0.1%. The fall in interest rates provided a reprieve to anybody coming off IO. Another factor to consider is that most IO loans are in relation to investment properties and are typically for terms of 5 years. Therefore, a lot of people would have been insulated from the IO crackdown and prices since 2020 have boomed so they have plenty of equity to play with. Worst case just sell it.

Totally different situation for owner occupiers dealing with rate rises, particularly for many recent purchasers who have been taking on records amount of debt.

 

@Redom, Once again a great post

A summary of RBA/APRA interventions/rate-cuts/TFF(QE), plotted on Sydney house price chart,

1. 2018 - mid19 => APRA IO rollover => SHP fell by 15% by may 19 [A (in chart)]
2. Mid19 - mid20 => RBA initiate IR cuts from 2% down to 0.1% => SHP rises by 15% by SEP20 [B (in chart)]
3. Oct20 - mid21 => RBA launches $188bn TTF to further lowers the MR as RBAs cash rate is already, Banks with a mix and match of market and TFF issue close to 4/500bn in extremely cheap fixed rates loan schedule to expire from 2023. => SHP after TFF jumps further by 30%. [C (in chart)]
4. In short, RBA/APRA between May19-Dec21 pumped Sydney HP by 45%
   It appear Sydney HP is in close sync with available borrowing capacity.

PS:
I still remember this post This Housing Downturn is Over, spot on and what a timing mate.

 

So we avoided it last time.... because rates dropped...so if you were paying 4.25 on IO on $1m. Total repayment per annum is $42.5k.....PI would be north of $65k. But drop to 2.2% it drops to about 40-42k. So same as IO repayment.

Question is what happens if rates head past 4.5%.....interesting isn't it?

 

@Redom, with zero cash rate and $188bn TFF (QE) later,
Do you foresee a new bigger TFF, when cheaper fixed rate loans come to expiry in 2023?

 

I am ok with this… but…

Westpac bank warn of interest rate rises, huge drop in property prices | Daily Mail Online