Unlock the secrets to property prices and interest rates

How Interest Rates Shape What You Can Afford to Borrow

Interest rates directly control how much a lender will approve you to borrow. Lenders assess your capacity to service a home loan at an interest rate that is at least 3.0 percentage points above the actual loan product rate. If variable rates sit at 6.2%, your application is tested at 9.2%. A buyer approved for $450,000 at a lower rate environment might see that figure drop to $380,000 when rates climb, even if their income stays the same.

Consider a buyer earning $75,000 annually with minimal other debts. At a loan product rate of 5.8%, tested at 8.8%, they might qualify for around $420,000. If the product rate increases to 6.5%, the test rate becomes 9.5%, and their borrowing capacity falls to roughly $390,000. That $30,000 reduction means certain suburbs or property types move out of reach, even though their income and deposit haven't changed.

For first home buyers with a small deposit, this compression matters. If you've saved a 5% deposit on a property valued at $600,000, you need approval for $570,000. A rate increase that drops your capacity to $540,000 means you either need to save more, look at lower-priced areas, or wait until rates stabilise. The Australian Government 5% Deposit Scheme can reduce the deposit barrier, but the serviceability test still applies at the higher rate.

When Rates Rise, Property Prices Usually Fall

When interest rates increase, fewer buyers can borrow enough to compete at previous price levels. Demand softens, and sellers adjust their expectations. In Melbourne's inner and middle ring suburbs, this dynamic plays out quickly. A property that attracted eight bidders at auction during a low-rate period might see three or four when rates have risen, and the winning bid often reflects the reduced borrowing capacity of the remaining buyers.

This doesn't mean all properties drop by the same amount. Homes in areas with strong employment, transport links, and amenity tend to hold value better than those in fringe locations. Buyers with larger deposits or higher incomes are less affected by rate changes, so the premium end of the market often experiences smaller price corrections than entry-level stock.

As an example, a two-bedroom unit in Oakleigh that sold for $650,000 during a low-rate phase might struggle to reach $600,000 six months later if rates have climbed. The property hasn't changed, but the pool of buyers able to service a $617,500 loan at the new test rate has shrunk. Buyers who waited through the rate increase now have more negotiating power, while those who purchased earlier may see their equity position stall or reverse in the short term.

Why Falling Rates Push Prices Higher

When rates drop, borrowing capacity expands. A buyer who could borrow $400,000 at a 6.5% product rate might qualify for $450,000 when the rate falls to 5.5%. That additional capacity flows directly into property prices, particularly in suburbs where supply is constrained. Sellers recognise the shift and adjust their price expectations upward, often quickly.

In our experience, buyers who enter the market at the tail end of a rate-cutting cycle face a narrower window. Once a few cuts have occurred, prices begin to recover and competition intensifies. Buyers who secured pre-approval earlier in the rate decline often find the properties they were targeting have moved beyond their budget by the time they're ready to purchase. The advantage of lower rates gets absorbed into higher prices.

The Timing Problem First Home Buyers Face

The ideal time to buy is when rates are high and property prices have softened, but that's exactly when borrowing capacity is most constrained. Most first home buyers need near-maximum borrowing capacity to enter the market, so purchasing during a high-rate environment often isn't realistic. By the time rates fall enough for capacity to improve, prices have usually started climbing again.

This creates a narrow decision window. If you wait for rates to drop further, you might gain borrowing capacity but lose that advantage to rising prices. If you move too early, you're servicing a higher rate and may face a short-term equity reduction if prices continue to soften. There's no perfect answer, but understanding the trade-offs helps you make a decision based on your specific situation rather than trying to time the market.

We regularly see this with buyers who delay for six months hoping for another rate cut, only to find the properties they were watching have increased by more than the rate saving would deliver. The property that was $580,000 is now $620,000, and even though the repayment on $620,000 at the lower rate is similar to $580,000 at the higher rate, the deposit required has jumped from $29,000 to $31,000, and the stamp duty has increased as well.

What the Debt-to-Income Limit Means for Your Capacity

From 1 February 2026, lenders may approve no more than 20 per cent of new owner-occupier loans to borrowers with a total debt-to-income ratio of six times or greater. If your gross income is $80,000, a DTI of six times means total borrowing of $480,000. Some lenders will still approve loans above that threshold, but you'll compete for a limited pool of approvals, and those are typically reserved for borrowers with strong financial profiles.

For buyers with a small deposit, this limit layers on top of the serviceability test. You might pass the serviceability assessment at the test rate but still hit the DTI cap. The result is that your approved loan amount is lower than it would have been before the DTI limit was introduced. This particularly affects buyers in Melbourne's middle and outer suburbs, where property prices sit in the $600,000 to $750,000 range and require borrowing close to or above the six-times-income threshold.

If you're earning $75,000 and targeting a $650,000 property with a 5% deposit, you need to borrow $617,500. That's just over eight times your income, well above the DTI threshold. You'll either need a larger deposit, a co-borrower, or a lower-priced property. The home loan pre-approval process will clarify which lenders have capacity to consider your application and what structure gives you the most flexibility.

How Fixed and Variable Rates Affect Your Strategy

A fixed rate locks in your repayment for a set period, usually one to five years. If rates rise during that period, you're insulated. If they fall, you're locked in at the higher rate unless you're willing to pay break costs. A variable rate moves with the market, so your repayment adjusts as rates change.

When rates are high and expected to fall, fixing can mean you miss out on future cuts. When rates are low and expected to rise, fixing provides certainty. A split loan structure lets you fix part of your loan and keep part variable, giving you some protection against rate rises while retaining flexibility if rates fall. The right choice depends on your risk tolerance, how long you plan to hold the property, and whether you prioritise certainty over flexibility.

For first home buyers, the decision often comes down to cash flow. If your budget is tight and you can't absorb a rate increase, fixing provides breathing room. If you have buffer in your repayments and expect to make extra payments or refinance within a few years, variable or split might suit. The refinancing to reduce your rate page covers how to reassess once your fixed period ends.

The Role of Deposit Size in a Changing Rate Environment

A larger deposit reduces your loan amount, which lowers your repayments and improves your serviceability. It also reduces or eliminates Lenders Mortgage Insurance, which is charged on loans above 80% LVR. For a $600,000 property, a 10% deposit means borrowing $540,000 plus LMI. A 20% deposit means borrowing $480,000 with no LMI.

When rates are rising, a larger deposit gives you more chance of meeting the serviceability test. When rates are falling and prices are climbing, a smaller deposit gets you into the market sooner, but you're servicing a larger loan and paying LMI. The low deposit home loan options available through the Australian Government 5% Deposit Scheme let eligible buyers avoid LMI even with a 5% deposit, which can make the difference between entering the market now or waiting another year to save.

Call one of our team or book an appointment at a time that works for you. We'll run the numbers for your situation, show you how rate changes affect your borrowing capacity, and identify which home loan options and schemes you're eligible for. The conversation takes about 30 minutes, and you'll walk away with a clear view of what you can borrow, what that means for property prices in the areas you're considering, and whether now is the right time to move.

Frequently Asked Questions