Amid low interest rates, a spike in auction clearance rates and stock markets all over the world rallying, the International Monetary Fund (IMF) wants to introduce tougher lending rules for banks to stop another GFC-like crash. It’s a no-brainer. As interest rates drop, most investors react in a number of ways: Keep their money in the bank earning a lower return Move their wealth into higher-yielding assets such as stocks Catch up or organise their home loan, including making extra repayments or locking in a fixed rate Buy or invest in property Over the past 20 years Australia has enjoyed…
To keep reading, enter your email address or login below.
Amid low interest rates, a spike in auction clearance rates and stock markets all over the world rallying, the International Monetary Fund (IMF) wants to introduce tougher lending rules for banks to stop another GFC-like crash.
It’s a no-brainer. As interest rates drop, most investors react in a number of ways:
- Keep their money in the bank earning a lower return
- Move their wealth into higher-yielding assets such as stocks
- Catch up or organise their home loan, including making extra repayments or locking in a fixed rate
- Buy or invest in property
Over the past 20 years Australia has enjoyed a solid GDP growth trend that has exceeded much of the developed world. Spurred on, in part, but a surge in resource investments and huge amounts of exported commodities.
But now with investment in mining related activities trending downwards the Reserve Bank of Australia (RBA) has lowered interest rates to stimulate spending in the none-resources sectors of the economy. This is good when the non-resource sectors such as property, construction or retail haven’t already experienced massive growth.
Australian property has experienced massive price increases in past two decades as a result of the economies constant growth and increasing population. Now both investors and owner-occupiers could be faced with higher LVRs or loan-to-value ratios. An LVR is the amount of money lent to owners against the value of the asset.
The Australian Prudential Regulation Authority or APRA is the body responsible for banks’ lending standards and last week warned them not to get lax on standards to increase market share. According to the Australian Financial Review APRA “has hinted it is concerned about the industry’s rising exposure to property” and has “opened the door to imposing limits for the first time in a decade on how much can be lent to home owners”.
The IMF has said that ‘macroprudential policies’ should be used to control excessive mortgage borrowing. This type of control could have helped the US before its housing collapse.
Citigroup recently published a report which stated that rising house prices would likely cause the RBA to be more cautious when it decided whether or not to cut interest rates, “the scope to cut would be compromised if house prices continue to accelerate and precipitate a surge in leverage”.
However Citi economists Paul Brennan and Josh Williamson said “we doubt APRA and the RBA are ready to follow the Reserve Bank of New Zealand in announcing controls on LVRs of housing loans”.
Despite APRA remaining open to the controls, RBA governor Glenn Stevens previously questioned their usefulness because they increase the chances of lending in unregulated environments.
What does this mean for investors?
The risks to property investors are quite obvious and those considering borrowing more whilst interest rates are quite low should first fully appreciate the costs and future serviceability of loans. For example as you can see the in the following graph, interest rates aren’t restricted to single digits levels and investors must consider whether, or not, they can still met the repayments of a loan if the interest rate were to spike by 0.25%, 0.50% or even 5% in the short to medium term.
Arguably the biggest concern for investors buying property (or anything for that matter) when it is expensive is the increased risk of making a capital loss. Couple a falling house price with an increased loan and you’ve got much more downside if things go belly up.
This Fool is of the opinion that many of Australia’s favourite stocks are overpriced. In addition, I believe that many of the big banks are not buys at current prices. They face many headwinds in the short term such as falling interest rates and rising unemployment.
As per the next graph, ANZ (ASX: ANZ) and NAB (ASX: NAB) have the lowest exposure to property markets but derive much of their revenue growth from international markets and business banking. Commonwealth Bank (ASX: CBA) and Westpac (ASX: WBC) have the greatest market share of mortgages.
Successful investing, whether in property or equities, requires us to buy things as cheap as possible and sell at the peaks. Although it may be hard to argue that we are currently experiencing a property bubble, lowering interest rates will only increase investors’ tendency to pay a higher price for both property and high yielding dividend stocks. However it is increasingly likely, since the Aussie dollar is proving to be resilient, that interest rates will be cut further.
It’s not too late to grab a great high yielding dividend stock! Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”
- 5 small caps for your watchlist
- Fund managers cautious of Aussie bank stocks
- Property versus shares
- Are ‘defensive’ stocks the best place for your money
Motley Fool contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies.