Avoid a catastrophe when interest rates rise
Property investment profits depend on several factors. For example, location equals property investment profit, and comprehensive research and due diligence is essential to ensure potential becomes a reality. While there are many facets of property investment entirely within the property investor’s control, one of the most important elements that cannot be fully controlled is mortgage interest rates.
Conventional wisdom tells us that rising interest rates are bad news for property investment opportunities. But, is conventional wisdom always right? It’s my experience that rising mortgage rates don’t necessarily mean falling profits from your investment property.
I’ll explain why an increase in mortgage interest rates is not as black a cloud as most property experts would have you believe. You’ll also discover how to prepare for higher rates and profit in any economic condition.
Interest rate rises are a drag on investment property prices
Let’s start by looking at the accepted effect of a rise in buy-to-let mortgage interest rates on property investment.
When interest rates rise, there are several effects on property valuations. For example:
- Mortgages become dearer, and the extra expense makes a home purchase less affordable
- With higher interest rates, banks tend to have less access to funds to lend – so the availability of mortgages decreases
So, the likelihood is that higher interest rates will be a drag on the demand for homes. The very simple supply and demand rule tell us that a decrease in demand leads to a fall in prices.
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Interest rate rises lead to rising investment property prices
Developers aren’t stupid people. They understand that a increase in mortgage rates could lead to a fall in demand for their properties, so guess what they do? That’s right, they scale back their plans for new build as they attempt to keep prices firm and their profits stable and growing.
In other words, rising interest rates could reduce the supply of new homes. It, in turn, has a positive effect on investment property valuations: lower supply equals rising prices.
The interest rate effect is not a straightforward equation
As you can see, rising interest rates has a duel effect on property prices by being a dampener of both supply and demand. In reality, which is affected the most severely depends on how far and how fast interest rates rise. A gradual rise is less damaging than a rapid hike in mortgage interest rates.
However, the effect on investment property prices also depends on why interest rates are rising.
For example, if a rate rise is made because the economy is strong, this is also likely to mean that wages are rising. This rise in wages negates the rise in mortgage payments. In this scenario, investment property valuations could be unaffected.
On the other hand, if an increase in the Bank of England base rate is made for other reasons – such as to protect the pound from falling against other currencies – and mortgage rates follow, then there’s little or no cushion against increased mortgage payments. In this case, the rate of growth of investment property prices is more likely to slow down, and valuations may even fall.
Buy-to-let mortgage rates and the property investor
Rising mortgage rates will have a direct effect on you as a property investor. Putting the effect on property prices to one side, higher mortgage payments directly impact your costs. For most property investors, the buy-to-let mortgage is their biggest single expense. Should this rise too high, the extra cost could turn positive cash flow into negative.
Now, if the interest rate has increased because of a strong economy, your tenant is likely to be earning more. You may be able to increase rents to compensate for the higher mortgage rate and maintain the status quo.
As we’ve seen above, if interest rates rise despite a sluggish economy people will be less able to afford new homes. Instead, they’ll turn to rental properties for their housing needs. It pushes up demand for investment property, and extra demand translates into higher rents – and shorter void periods.
How to prepare for higher buy-to-let mortgage interest rates
Weighing up the various scenarios in which interest rates might rise, a hike in mortgage rates might:
- either push investment property values up or down; and
- allow you to increase the rent you charge your tenants
While higher mortgage payments will increase your costs, higher rents could offset at least some of this higher cost. It’s this ambiguity of effect that leads me to always take a cautious approach in cash flow calculations:
- Allow for a hike in interest rates, and you’ll always be prepared for if mortgage rates rise (and when)
- Save into a contingency fund from your positive cash flow
- If you’re concerned about higher mortgage interest rates, speak to a buy-to-let mortgage broker about fixing your rate
Above all else, those things that you do have complete control over – make sure you do them right. Buy investment property in the best places to invest in property UK. Do this, and the full profit potential of your investment property will be realised because of consistent and constant demand from buyers and tenants.
Contact one of our team today on+44 (0)207 923 6100, and we’ll help you devise an investment strategy that helps you to profit throughout the property and economic trend cycle. Whatever happens to interest rates, your property portfolio will be prepared.
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