Property investors are increasingly over-extending themselves and will struggle when rates inevitably rise, according to an investment advice firm.
Grayden Taylor, Elston Portfolios' investment manager, said the current low interest rate environment was presenting Australians with “tempting” conditions and many were “failing to consider their financial situation” in the context of a market with higher rates.
“There is no doubt that investing in a low interest rate economy is preferable, because the lower cost makes it easier to hold, and the investor may be able to afford to make larger payments on the principle of the loan,” he said.
“However, we have been existing in this low interest rate environment for around two years now, and it can be easy to forget that interest rates are at historic lows, and are inevitably going to rise – whether it’s in nine months or two years, it will happen.”
Mr Taylor said capital city investors who are taking on a high level of gearing would be the hardest hit.
“What we are starting to see is buyers are looking at how much of a loan they can afford to service with interest rates at current levels, and are therefore able to borrow more and pay more for a property.
“However, if interest rates rise only 2.5 per cent, this would double the cash rate. Given this is such a low base, we are looking at a dramatic impact on repayments. In fact, it is much more than we have seen in previous interest rate cycles, just because rates have dropped so much.”
Investors should always consider the worst case scenario when investing in a historically low interest rate environment, according to Mr Taylor.
“Times are good now, and banks are lending generously because investors can afford to borrow more. However, the amount of prospective buyers will most certainly drop when rates are higher, and lending approvals therefore are lower,” he said.
“Investors in mortgage stress because they overextended when interest rates were low will be most affected when demand is significantly lower, and there are fewer buyers with money to spend.”
Mr Taylor said investors needed to be particularly cautious of added complications, such as servicing a loan at a higher interest rate when gearing in a self-managed super fund.
“Contribution caps in place may make it more difficult to service a loan as rates rise, particularly when the loan to value ratio is too aggressive. This leads to an increased likelihood of being a forced seller at the wrong time, if the super fund doesn’t have the liquid assets to service a loan.”