While demand for property outstripping supply is often blamed for the ramp-up in property prices, interest rates at historic lows are also behind booming prices.
Borrowing has not been as cheap for 50 years, with the Reserve Bank leaving the cash rate at a record low 2.5 per cent for more than a year.
The danger for first time buyers, in particular, is in thinking that super-low interest rates are the new normal. The next move in rates, though it may not be for a while, will very likely be up.
Home-owners with mortgages, would-be home owners, and investors should factor higher rates into their calculations.
Most analysts are not expecting the Reserve Bank to start increasing rates until at least the middle of next year at the earliest.
Inflation is likely to remain in the Reserve Bank's 2 per cent to 3 per cent target band. However, if the value of the Australian dollar was to fall much further, pushing the prices of imported goods higher, or wages started to growing strongly, inflation could pick up.
Regardless of the timing, at some point, interest rates will have to return to normal levels. Economists say that when rates rise they will probably have to rise by less than previous cycles given that the size of the typical mortgage is now much larger.
Robert Mellor, the managing director of property forecaster BIS Shrapnel, is expecting a rise in the cash rate of about 1 percentage point by the end of 2016.
Nevertheless, opinions among economists differ and home buyers and investors should be factoring a rise in mortgage rates of at least 2 percentage points into their repayment calculations, says Peter Arnold, a product director at researcher RateCity. He says borrowers should prepare a repayment buffer now in anticipation of rising rates.
RateCity's database shows the average standard variable rate is 5.37 per cent, which for a typical home loan of $300,000, means a monthly repayment of about $1800.
"If we see rates return to historical averages of around 7 per cent, borrowers need to be ready to repay an extra $300, on average, per month," he says.
It is up to consumers to decide how much they can borrow, he says.
"Don't take the banks' word for it, do your own sums and don't borrow too much," Arnold says.
Mitchell Watson, the research manager at Canstar, agrees that borrowers must do their sums very carefully.
Watson says consumers are likely to be enjoying low interest rates on all of their credit, not just their home loans. That means when interest rates start to rise there will be higher repayments on all credit not just the home loan.
"Once rates do start going up, many people will feel the pinch, especially if they have taken advantage of low rates to buy that new car, for example," Watson says.
While the decade average for home loanrates is about 7 per cent, mortgage rates were above 9 per cent only six years ago, Watson says.
Fixed interest rate mortgages give certainty over repayments. Watson says the average one, two and three-year fixed rates on home loans are all below the average standard variable rate.
Fixed rate loans generally have less flexibility than variable rates mortgages. Watson says you may not be able to make as many additional repayments as you would like to and there may be a break cost if the loan is repaid before the end of the contract period.
"It may have an attractive interest rate but may not come with all of the bells and whistles that you like," Watson says.
Action plan
- Cash rate is at 50-year low
- Interest rates and, therefore, mortgage rates will eventually rise to normal levels.
- That could see the average standard variable mortgage rise from about 5.4 per cent to about 7 per cent.
- Experts say home-buyers should factor in a rise in the mortgage interest rate of 2 percentage points, just to be on the safe side.
- Most fixed interest rate mortgages have lower rates than variable rate mortgages. But fixed rate loans are less flexible than variable rate mortgages.
