This seems like a pretty simple question with a very obvious answer. The higher interest rates are the higher the interest costs payable for borrowers. End of story….or is it?
Interest rates need to be looked at in a bit more detail to try and understand how they affect your own situation, whether it be as a homeowner, property investor or business owner.
- HOMEOWNER – if you currently have a home loan you will be paying interest at the lowest home loan variable rate seen in the last 30 years. These rates peaked in 1990 at around the 17% mark. Compare this to anything between 4% and 5% you would currently be paying. However, still remember this interest cost is not tax deductible so it is still an “after-tax” cost. Therefore, it makes sense to pay this debt off as quickly as you can to give you some form of guaranteed saving (even if it is boring).
- PROPERTY INVESTOR – you should be paying under 5% on your variable property investment loan. Again, this is “cheap” money, which makes it extremely affordable to borrow as your monthly interest cost is so much cheaper than paying interest rates of close to 10% from a decade ago. Does this mean you should be buying as many investment properties as you can afford? Well it depends.
- BUSINESS OWNERS/FARMERS, etc – cheap interest rates means you can borrow more for investment assets such as freehold or farming land. Should you be mortgaging every parcel of land you can find up to its maximum limit because interest rates are so cheap? Again………….it depends.
Nothing I have provided above is new or news to anyone. However there are some factors which are often overlooked when borrowers are considering using the cheapest interest rates available in our lifetimes. These include the following:
- Property Values – lower interest rates are one of the major factors in the increase in property prices over the last 10-15 years. So on one side of the transaction, yes, you might be paying about half the interest rate you were paying 10 years ago, however also remember the cost of the same property might be triple what it was in 2006. If you are a property investor, DO NOT ASSUME the same rate of growth in property values in the next decade as what has happened in the previous decade. It is unlikely that interest rates will decrease at the same rate as they have over the last 10 years. If interest rates plateau, or heaven forbid interest rates rise, this will make the cost of finance more expensive which in turn may put pressure on property values. If property values decrease, equity percentages will decrease. Banks will have equity limits for clients which need to be kept in line. If these equity limits are breached, this will require either debt levels to reduce or potentially assets to be sold.
- Interest Rate Increases – Have you “stress tested” your current financial position? If you are a HOMEOWNER could you handle the increased repayments if interest rates rose by 2%. If you are a PROPERTY INVESTOR could you support a rise in interest rates which would cost you even more cash flow per month? Remember, even if you are negatively geared you only get back a percentage of your taxation loss from the ATO. If you are a BUSINESS OWNER/FARMER how much extra cash flow would it cost if interest rates rose by 2%? Remember, if you buy land at $2,500 per acre, borrow the lot and your cost of finance is 5%, then it is costing you $125 per acre in interest before you pay for any inputs.
The most important thing to keep in mind with borrowing money and managing interest rates is to make sure you have a plan and you can manage interest rate rises.
If you are a homeowner, make sure you try and pay off your home loan as quickly as you can. This will be one of the best investment decisions you will ever make.
If you are a property investor, do your research to make sure your investment is not a dud and the rest is all about cash flow. Interest is still a cost so it makes sense to reduce this cost if you can. The best time to reduce your investment property debt is when interest rates are low. Eventually you want your property investment to be putting money back in your pocket!
If you are a business owner/farmer, again do your research so you know what your top price is to make the investment viable. Understand what income you will have to make per acre to become profitable, then determine whether this is an appropriate investment for the amount of money you will outlay and the risk you will be taking on.