I know, I know, the property market is way overvalued. Why would anyone, especially someone born after 1983, go out and get a home loan?
I understand, and I hear you. The figures are eye-watering too.
Did you know figures from multiple property research outfits show house prices in Sydney and Melbourne are 40 per cent overvalued? And, according to SQM Research, next year prices will again grow in the double digits, before falling back.
Extraordinarily, though, everyday borrowers and investors are still taking the plunge. Why? Well because interest rates are now sitting comfortably at historic lows.
There’s one problem though, interest rates will likely rise next year, independently of the Reserve Bank. That could make obtaining a home loan a little tricky.
Reserve Bank’s thinking
For the uninitiated, the Reserve Bank is Australia’s central bank. The RBA, to a large extent, determines how much money costs. What do I mean by that? Well “interest” is the “price” of money. That is, when you borrow money, you effectively ‘buy it’. The interest you pay on the loan is the “cost” of that debt. The RBA can control how much money costs by raising and lowering the “official” cash rate.
For what it’s worth, changing the official cash rate is meant to affect other interest rates too, like the ones applied for your home loan. So what the bank does with the official cash rate matters. It can influence your family or personal budget quite a bit.
When the bank meets to discuss what it’s doing with interest rates, it’s concerned about two main things: inflation (how much prices at the store rise), and the labour market. Right now, inflation is kind of sluggish. That’s because folks’ wages are growing at their slowest pace since the 1990s and consumers are reluctant to spend-up big at the stores. In turn, wages are sluggish because employers aren’t handing out pay rises, or high-paying full time jobs as often. Instead, the younger generation, and those re-entering the workforce after a long absence, are pushed into part-time and insecure work. Neither inflation, nor the labour market are looking particularly crash-hot right now.
The Reserve Bank is all too aware of this. It’s why the official cash rate is at historic lows. Indeed the bank left the cash rate there for a fourth straight month last week.
Admittedly it looks as if the inflation rate has bottomed, and perhaps the labour market will improve, but for now, the RBA seems to thinks that’s a way off yet.
That means we now find ourselves in a very interesting position. Interest rates are at record low levels, and look as if they will stay that way until the end of the year.
OK, so then what?
Net stable funding ratio
Have you ever heard of the term “net stable funding ratio”? It's an international regulation which Australian banks need to comply with. It sounds complicated but it's part of a broad program to make banks safer and boost the amount they hold in deposits.
A very long story short, at least two major banks have indicated in recent company reports they are seriously working on incorporating this new ratio – by boosting the amount they hold in deposit.
Here’s the kicker: what it means is that banks will likely have to move away from their reliance on offshore or wholesale funding (which can be cheaper). So if the way banks collect the cash they use to dish out home loans becomes more expensive (relying more on Australian term deposits), then it stands to reason that mortgage rates will go up.
A little twist to that is that banks may not directly increase the rates they charge on mortgages. Instead, they may reduce the discount you're expecting to receive on your variable rate next year.
Another option is that the banks could take the hit in their bottom lines, but fund manager Steve Johnson thinks that is very unlikely.
So yes, you could be paying more that you thought you would on your mortgage next year. It’s entirely possible.
The banks are currently working on how they’re going to handle the increase in costs. Analysts I’ve spoken to say there’s a window between now and early next year where commercial rates will hold at record lows, before shifting up slightly.
RBA to the rescue?
Of course the Reserve Bank’s job is to protect consumers from so-called ‘greedy’ big bank gauging. The problem now of course is that the RBA is extremely reluctant to cut interest rates, in part due to the fact there’s little room to move!
If the RBA lowers rates, it risks further inflating an already dodgy housing market. If it increases rates, it risks snuffing out economic growth entirely. There’s also a suggestion the Reserve Bank will spook consumers if it lowers rates anymore, and that would hurt the economy too, somewhat ironically.
So the simple fact is that the RBA seems to have little by way of defences against the big banks hiking rates.
If you’ve found your dream home … go for it!
An overwhelming number of houses in capital cities on the east coast are significantly overvalued. However, that doesn’t mean that if you find your dream home later next year you shouldn’t buy it.
There are a few criteria I personally like to satisfy before buying a property. They include: can I afford the deposit? Can I afford the repayments (without too much fuss)? Is the property appropriate for me (and my partner – if you have one) right now? Will it continue to be? Does it need renovations? And if you have kids, is there a decent school nearby?
While financing has never been easier, interest rates will rise in the future. However, if you find your dream home, and you can meet the repayments, buying could still be an option down the track – especially if prices come down significantly as interest rates rise.
Next year is unpredictable
One thing I can say with absolute certainty is that no one can tell you definitively what the right course of action is in terms of when and how to finance a property. Without doubt, the best tools you have at your disposal are research (plenty of it), shopping around (for the best rate), and plain old common sense.
David Taylor is a journalist with the ABC. Before taking up a position with the ABC, David was a financial markets analyst and economics commentator. You can follow him on Twitter: @DavidTaylorABC.