How interest rates affect property prices
As the first Tuesday of the month rolls around, discussion in the Australian media inevitably turns to interest rates and the age-old debate of whether the cash rate should go up or down.
Often all this pondering translates to a discussion about property prices, but it begs the question, how exactly do the two interact?
Here’s a little insight into how interest rates affect property prices…
The cash rate
Interest rates are basically what your bank or lender charges you for the privilege of having a loan. It’s an additional amount that you pay back on top of the amount which actually pays the loan off.
In Australia, this rate is based on something called the cash rate, which is set by the Reserve Bank of Australia (RBA).
The RBA is the nation’s central bank and has the role of handling Australia’s monetary policy while also assisting in maintaining the nation’s financial stability.
As the RBA explains, “The cash rate is the interest rate that banks pay to borrow funds from other banks in the money market overnight. It influences all other interest rates, including mortgage and deposit rates.”
Where the cash rate sits helps balance the economy, and is influenced by an array of factors including inflation, employment, global economic conditions and more.
Each month the RBA makes a determination on the cash rate in a bid to help maintain the financial stability of the country.
The cash rate versus interest rates
Banks and lenders then use this cash rate to determine their interest rates, with their average variable interest rate tending to sit around 2 per cent higher than the official cash rate.
For example, in September 2024, the official RBA cash rate was 4.35 per cent, and the average Australian variable interest rate was 6.4 per cent.
Increases and decreases in the cash rate therefore have a direct impact on the monthly mortgage repayments for people with variable mortgages.
If the cash rate rises, the banks tend to follow suit, raising their interest rates, meaning people with a variable mortgage have to pay more each month.
If the cash rate falls, the opposite tends to occur. Should the banks choose to, they can pass on the decrease and lower their interest rates, meaning those with variable mortgages pay less each month.
But how does that then flow on to house prices?
How this affects house prices
Interest rates affect the property market in a series of ways, with the first being affordability…
Affordability – When interest rates are high, it becomes more expensive to service a loan. For example, if interest rates are 4 per cent, your monthly mortgage repayments on a 30-year $500,000 principal and interest loan would be $2387.08.
If rates rise to 5 per cent, those repayments would be $2684.11 ($297.03 higher) and if they hit 6 per cent, they would be $2997.75.
If you’re looking to take out a mortgage to buy a house, you need to demonstrate you can afford it, and the higher the interest rate, the more you need to earn in order to afford those higher repayments.
This potentially slows property price growth or even lowers prices as fewer people can demonstrate they can afford the $500,000 loan.
Mortgage stress – Another way house prices are impacted by interest rates is via mortgage stress. Say you took out a loan a couple of years ago when the cash rate was 0.10 per cent and interest rates were around 3 per cent.
At that stage you might have been paying a monthly mortgage of $2108.02, but now that’s probably more like $2997.75, which means the household budget is more stressed.
This can see people seek to sell their properties as servicing the mortgage has simply become unaffordable. The more people who opt to sell, the more stock there is on the market, which results in property price growth slowing or even reversing.
Urgency versus non urgency – In periods where interest rates are low, there’s often a sense of urgency.
People know lending conditions are favourable, affordability is good and repayments are lower, therefore they look to get into the property market while the going’s good.
Often this results in prices rising as the demand for property starts to outstrip supply.
On the flipside, when interest rates are higher, buyers might develop a wait and see attitude where they hold out to see whether:
- Interest rates will decrease, or
- Property prices will drop enough for them to secure a bargain.
This further slows the market, and potentially lowers house prices.
The final word
The relationship between interest rates and the property market is a complex one, but it’s not the only factor affecting house prices.
The bottom line is, like all markets, the property market goes up and down and ultimately choosing the right time to buy or sell becomes about what’s right for you.
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