In his recent column in Switzer, John McGrath gives some smart suggestions on how to make the most of today’s low interest rates.
Here’s what he had to say:
I suspect that even the most experienced economists in Australia were taken by surprise when the Reserve Bank reduced interest rates by 0.25% last week to take the official cash rate to a new record low of 2.25%.
The rate cut has been passed on in full by the big four banks and that’s fantastic news.
Mortgage repayments are the biggest expense incurred by home owners and investors so anything that reduces them puts money in our pockets for other things.
Many borrowers on professional packages will now be paying around 4.5% in interest depending on the amount borrowed and discounts available.
That’s incredibly low when you consider the average long term interest rate over the past 10 years is 7.21% (RBA).
So what opportunities do today’s historically low interest rates provide?
1) Pay down debt
This is possibly the best opportunity of all because it applies to so many people.
Around seven in 10 Australians own their own homes and about half have a mortgage (ABS Census).
Today’s low interest rates mean many home owners can afford to pay down more debt and create a nice financial buffer for themselves before rates go back up again.
You can make extra repayments and/or keep your repayments the same instead of letting the bank reduce them with each rate cut.
Tip: Get a redraw facility so any extra money paid in can be withdrawn in an emergency.
2) Neutral to positive cash flow investments
Even in Sydney, a neutral to positive cash flow investment is not too hard to find when interest rates are this low, particularly in the lower end apartment market.
Today’s rates make investing that much more affordable and manageable for the average person.
Tip: Calculate affordability based on the average long term interest rate of 7.21% or higher.
That way you’ll know you’ll be okay when rates inevitably rise again. Remember, property is a long term investment only, so you need to be able to hang on to it when rates go back up to 7% or more.
3) A leg-up for first homebuyers
There’s no better time to buy than in a climate of record low interest rates.
The most expensive part of a principal and interest loan is the first five years when the bulk of each repayment goes to interest.
Over time, as the principal reduces, a smaller proportion of your repayments goes to interest.
Right now, you can make those first five years pretty cheap.
Tip: Again, calculate affordability based on the average long-term interest rate of 7.21% or higher.
For extra peace of mind, consider a three or five year fixed rate well below 5% and make extra repayments when you can (check that your bank allows this on fixed loans).
Rate cuts and what it means for the economy
In many ways it’s a double-edged sword, so my advice is not to get too carried away.
While we in the property industry celebrate rate cuts because they create so many opportunities for our clients and usually give the market a bump, the big picture reality is that interest rates only go down when the economy needs support.
The RBA releases a statement after each monthly meeting summarising the reasons for their decision.
This month’s statement indicates the economy is expected to remain steady but on the weaker side for a while.
Consumer demand is weak, commodity prices are down and unemployment is expected to go a little higher.
We also need the dollar to continue moving downwards to help the economy grow and to support non-mining industries.
Buyers and home owners with mortgages need to consider how they might be affected by today’s economic situation.
Australia has a strong economy overall but that doesn’t mean much if you’re working in an industry where jobs are being cut.
Don’t take on new debt if you are concerned about losing your job.
No matter what else is going on, you need a regular reliable income if you’re going to own property.
On the flipside if your job is secure, then this is a phenomenal time in your life to build wealth by taking advantage of low rates.