The Effects Of Rising Interest Rates On Home Ownership vs Renting

15th OF February 2011

By Anthony Bell, Finance Expert
www.bellpartners.com

Interest rates keep going up and affording the mortgage is getting harder. What should homeowners be wary of? How tight is too tight? Will interest rates keep rising? Should renters stick to their lease contracts for now?

Whether or not interest rates will rise or fall inevitably involves a bit of crystal ball gazing. My take at the moment would be that with Europe and the United States still doing it tough, and the potential slowing effect of the recent floods, interest rates this year might be a little more stable in Australia than last year. If they do rise, it won’t be in big leaps. Naturally that can change if circumstances are a bit different to what we expect.

When taking out a mortgage, you should work out how affordable it would be for you if rates went up 3-4 percentage points from where they currently are. If you can’t afford your mortgage should rates go up this amount, you might be cutting it fine.

It might still make sense to get the mortgage, but with the knowledge that you should do everything you can before any significant rises to pay down a bit more of the mortgage or increase your earning capacity to give you more buffer.

You might get lucky and rates might not rise by much or even fall. Even so, no one wants to leave their mortgage affordability to luck! And if interest rates do fall, it’s normally sound financial management to keep making the higher repayments to reduce the debt.

The buying versus renting argument has gotten tougher with rates rising. Paying a mortgage does involve higher payments than rent. Plus there are the outgoings such as council rates or strata fees that a renter doesn’t normally pay.

The flip side is that the property owner gets the growth in the value of the property. They also get the piece of mind that comes with knowing that they won’t be required to move at their landlord’s request. A smart homeowner can also increase their wealth through some smart renovations and upgrades that add value in excess of any additional costs.

Another factor to consider is that your mortgage repayments generally won’t increase as fast as rent will. Most home owners find that within 5 years of purchasing their home that their mortgage repayments are the same or less than it would cost them to rent a similar property, despite rent initially being “cheaper”.

Take this example. Ten years ago, Jane Smith purchased a $300,000 property on a 6.5% mortgage over 30 years and borrowed the full amount. Her weekly repayments were around $470 a week. If she was renting the property, she might have paid $250 to $300 a week in rent, around $200 a week less. Ten years later, her mortgage interest rate could be 7.5%, and her repayments up to $520 a week due to the higher interest rates. However, the property is now worth $500,000 (with the increase in value going to her net worth) and rent if she was renting it, she’d be up for $500 to $550 a week, and rising every year after that, whilst the value increases. Many home owners will have similar stories to this.

The lesson is that buying a home is a longer term consideration. For short term cash flow, renting will normally win. For longer term wealth creation and piece of mind, home ownership can be a big winner.

For more information about your finances or to make an appointment with a specialist from Bell Partners, go to www.bellpartners.com