Interest rate rises may make it harder for first home buyers to get into the market

First home buyers may have celebrated interest rate rises that will likely send property prices lower – but they may be left worse off.

First home buyers hopeful of getting into the market thanks to an expected drop in house prices may now face another problem that could leave them worse off.

While interest rate rises will likely help bring house prices down, they also lower the amount of money people can borrow, and the gap between the two may not be as beneficial to buyers as first hoped.

Canstar has crunched the numbers and found that for a couple on a combined income of $180,000, their borrowing capacity will drop by 2.6 per cent thanks to the recent 0.25 per cent rate rise – meaning they will be able to borrow $34,000 less.

This would limit them to a loan of around $1.3 million.

However, if interest rates rise by 2 per cent, which many experts predict will happen by next year, their borrowing power would be cut by $227,000, to just over $1 million.

For a single borrower on an income of $90,000, their borrowing power would drop from $560,000, to $461,000.

Overall people could see their borrowing capacity reduced by almost 18 per cent if interest rates rose by 2 per cent, which means property prices would need to drop by more than this amount to leave them better off.

Experts are predicting substantial house price drops of anywhere between 5 per cent and 15 per cent, but these falls would not be enough to compensate for the reduced borrowing capacity.

Sydney prices may still prove challenging for first home buyers to afford. Picture: David Swift/NCA NewsWire

Looking to get onto the property ladder? Compare Money's first home buyer guide might help >

“When interest rates rise by 2 per cent and the average variable rate is closer to 5 per cent, buyers will need to look for properties that are $100,000 cheaper,” Canstar finance expert Steve Mickenbecker said.

Median house prices in Sydney for example, spiked 23 per cent in the past year.

Commonwealth Bank analysis suggests Sydney house prices could drop by nearly $200,000 by the end of 2023 – but would remain around $1.2 million – keeping it out of reach for the average first homebuyer.

HSBC is predicting a 5 to 10 per cent fall in Sydney and Melbourne, while AMP Capital suggests the cities could experience a 15 per cent by the end of 2023 or early 2024.

Borrowers who want to maximise their borrowing power are being advised to shop around for a better interest rate.

Mr Mickenbecker said the value of new lending to first home buyers climbed by 5.9 per cent in March but this activity was down by a staggering 25.2 per cent on the same time last year.

However, buying a cheaper property will still benefit people in the long run and also means they can get by with a lower deposit.

“First home buyers still waiting in the wings will be breathing a sigh of relief they have not bought at inflated prices, and have been dealt time to get their deposit together,” Canstar finance expert Steve Mickenbecker said.

“Those who stretched their budget to get in last year are amongst the most vulnerable to higher rates and will be nervous.”

RateCity.com.au research director Sally Tindall told news.com.au rising interest rates would provide a reprieve to constantly rising prices but first home buyers should crunch the numbers before they pop the champagne.

“First home buyers should think carefully about overextending themselves in a market where rates are set to rise and prices are forecast to fall,” she said. “Make sure you have a buffer to ride out any bumps.”

As part of the election campaign, the Coalition has announced it would extend its Home Guarantee Scheme if elected, which allows first home buyers to purchase a property with a 5 per cent deposit.

Labor has released an equity scheme that will allow low and middle income earners to buy a home with a deposit of just 2 per cent, and says it will also build more social and affordable housing.