The sensible person buys when interest rates are coming down. You cant do that at the moment because they are already as low as they have ever been. The next move has to be up. You never buy when interest rates are rising.
If you dont understand why I will explain.
The most important point about house prices is not the sale price but the cost. They are different. If a house price is £100,000, and you need an 80% mortgage, you are borrowing £80,000. The most important calculation you can do is to work out if you can afford the mortgage payments.
If interest rates are at 1%, and your bank is charging you 2% over base, then you will be paying 3% interest on the money borrowed. That works out to £2,400 a year. Add that to the repayment figure of the mortgage and that is your annual cost. If the mortgage is a repayment loan over twenty years you are going to have to pay £2,400 plus £4,000 every year to service and repay the loan. Total: £6,400.
If interest rates rise by 2% your total repayments for a year will be £8,000. That’s a heck of a difference. The crucial question is: how much can you afford? If interest rates go up you can afford less and therefore will not be able to chase up house prices.
Now look at the current situation. If interest rates in the UK are 0.5% your mortgage payments are piddling. No problem. Great news. But what happens when they rise? You get squeezed into default. There is a way round that. I’m sure you can work it out. If you cant you shouldn’t be in this business, but for those who are just starting out, here is the simple way to deal with the possibility of rising interest rates.
You take out a short term mortgage, say 15 years. If interest rates go up to a level you cant cope with, then you go to your broker and arrange for the loan to be adjusted over a longer term.
So, how about things right now? I have news for you. Interest rates will rise. They have to. Just look at the charts. I have them back to 1200. Is that far enough back for you? Look and enjoy.
Rates between 3% and 7% appear to be the norm. We will assuredly return to the norm sooner rather than later. Can you afford those rates? If not, you are heading for wipe-out.
That’s why the professional always buys when rates are high but coming down. Life gets easier that way. Buying when rates are low means things can only get harder. Which do you prefer?
The interesting thing is that when interest rates are high house prices tend to be low. This means if you start to buy as the rates come down you get two benefits; an increasing return on your investment as your mortgage gets cheaper, and so your expenses come down and therefore your profit goes up; and as interest rates come down houses generally become more affordable so people start to buy, and prices start to rise, so you clock up some capital gains as well.
Interest rates are geared to the rates the central government has to pay to borrow. It is interesting to watch the cost of government borrowing. If the government does not need to borrow then generally speaking rates can stay low. That is not always the case. Interest rates may have to remain high for other reasons, but I dont want to get too technical here. All we need to know is what is driving the rates at the moment, and how things are likely to pan out in the future.
We have recently seen what happens in Greece. They run out of money, so they have to borrow. Investors dont want to lend to a bad risk. They will continue to do so, but only if the return is attractive enough. That return is the interest rate. It goes up when times are tough. Greece’s borrowing costs went rapidly from about 3% to 23%. That would normally reflect in the rates governing all borrowing within that currency. However, Greece got bailed out by Germany and the IMF. All is well for the moment, but for how long?
What about the UK? The government’s borrowing requirement is very high. If there is a whiff of fear that the government wont be able to repay its borrowing, then interest rates will rise, and, as we saw with Greece, they can rise sbstantially very quickly.
One of the things we have to watch for is the probity of the government of the country we are invested in. That puts the USA right out of court. The currency will survive as long as it is the currency of last resort. That situation is likely to change drastically sometime during the next ten years. However, maybe the euro will implode first. Who knows? But one thing is certain, there are two ways governments can deal with their problems. I am ignoring the proper solution, which governments never take, and that is, to cut their expenses and run a tight economic ship.
The two popular alternatives are: print money and pay debts with that; or encourage inflation which reduces the value of the debt. Usually, the first alternative encourages the second in any case. (Strictly speaking, an increase in the money supply is the definition of inflation. There can be a delay in that supply feeding through to the market, and that is what is happening at the moment.) Controlling the level of subsequent price rises under these circumstances is well nigh impossible.
Have a look at what happened during the last cycle of interest rate rises:
Interest rates up to 15%. Excuse me, but that is financial suicide.
You have been warned.