03 Mar
An increase in interest rates significantly affects all types of investments, including real estate. The impact of interbank exchange rates and treasury bills are so overwhelming that they affect the ability of an individual to purchase residential properties. This results in people incorrectly assuming that the deciding factor in the valuation of real estate is the current mortgage rate. However, mortgage rates are only one interest related factor that can impact property values.
It is essential to highlight that while interest rates affect property values, they are influenced based on the supply and demand for existing properties and the costs incurred to develop new properties. Furthermore, property values are also impacted by government-influenced interest rates, capital flows, and the mortgage financing rates. Variance in interest rates directly and significantly impacts the financing costs and mortgage rates, consequently affecting real estate values.
A lender charges an amount to the borrower for the use of capital, and this sum is known as the interest rate. To determine the percentage of interest rate to be charged, the banks will consider a number of factors such as the current state of economy and the level of competition in the market. The central bank of a country determines the prime interest rate which is then used by other banks to set the range of rates that would be offered to citizens. When a high interest rate is determined by the central bank, the cost of debt rises as well. Because the cost of debt rises, it discourages people from borrowing from the banks, and this results in the reduction of consumer spending. Furthermore, raising interest rates is a common tactic to combat inflation.
Interest rates typically rise during economic expansion periods resulting in various classes of assets reacting in a unique manner. Increasing rates erode the yield of bonds, affecting the value of stocks, and impact interest payments on debt. However, it is important to highlight that real estate investments tend to perform well in a rising rate environment.
Moreover, the supply and demand for competing investments and capital greatly affect the required rate of return (RRR). In addition, with decreasing interbank exchange rates, the cost of capital is reduced resulting in more funds flowing through the system. Consequently, when the rates increase, the availability of funds decreases as well. With regards to the real estate market, changes to interbank lending rates will either increase or decrease the amount funds available for investments.
When applying for a mortgage, the key aspect to consider is that mortgage comes in two forms which are fixed rates and adjustable rates. A hybrid version of the two forms can also be obtained by the borrower, depending on their financial stability. If a customer purchases a property on fixed mortgage rate, their interest rate is fixed for the duration of the mortgage term.
On the other hand, adjustable-rate mortgage payments can change on a monthly basis, every six months, or annually. This depends on the term of the mortgage held by the consumer. Canadians purchasing a home with mortgage financing must consider that changes in interest rates can affect the housing market. This is because these rates determine how much the customer would have to borrow for the purchase of their property, which would influence the overall value of the real estate property. By having low interest rates, the demand for property increases which would increase the purchasing price of the property.
