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Investors are overextending in the low interest rate environment, and failing to plan for future rate rises, warns an investment firm.
According to Elston Portfolios investment manager Grayden Taylor, the current climate presents Australians with tempting conditions to take on a level of gearing to purchase growth assets, such as property.
“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 that buyers are looking at how much of a loan they can afford to service with interest rates at current levels, and they are therefore able to borrow more and pay more for a property,” he said.
“However, if interest rates rise only 2.5 per cent, this would double the cash rate. Given this is from 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.”
Mr Taylor said investors should consider the worst-case scenario when investing in a historically low interest rate environment.
“Times are good now, and banks are lending generously because investors can afford to borrow more. However, the amount of prospective buyers will certainly drop when rates are higher, and lending approvals therefore are lower,” he explained.
“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.”
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