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How to prepare for climbing interest rates

Financial Planning  |  26/10/2017  |   7 min read

Interest rates have been low for so long it’s tempting to think our current rates are the new normal. That ignores both history and the warnings from the Reserve Bank.

The official cash rate has been held at a record low 1.5% since August 2016. This has encouraged investment, and has kept Australia’s property market on an upward trajectory.

But in a recent speech Reserve Bank Governor Philip Lowe suggested that 3.5% is a more sustainable ‘neutral’ cash rate. Neutral is central bank-speak for the sweet spot where growth is supported without pushing inflation too high. While any increases are dependent on a complex series of triggers, it’s worth considering the implications – and what you can do to insulate yourself.

Wages and inflation keep rates low

Annual wages growth is currently running at below 2%, which means many workers are standing still after inflation is taken into account. The annual rate of inflation eased from 2.1% to 1.9% in the June quarter, below the central bank’s 2-3% target band. 

The central bank is also reluctant to put more pressure on borrowers while household debt grows faster than income. The level of household debt to income has increased from about 148% in 2012 to a record 190% in March 2017. For households with a mortgage, the figure is closer to 300%. That means any potential rises can have a significant impact on the family budget.

Quit the bad debt habit

Make the most of low interest rates to pay down expensive debt such as credit cards and personal loans. Credit card interest rates begin at around 12% and rise to as much as 20% on popular rewards cards. 

One strategy is to consolidate personal debts into your mortgage and save up to 15% in interest. You also need to increase repayments on your mortgage, otherwise you could be paying off your credit cards for 20 years or more. 

Lock in fixed rates

If you have a mortgage where any increase in interest rates can blow a hole in your budget then consider fixing all or part of your loan. 

The best fixed rates for two and three-year terms are currently around 4%, not much more than the best variable rates on offer. 

Bear in mind that fixed loans are less flexible than variable loans. You can’t make extra repayments or redraw funds and there are penalties for exiting a fixed loan early, even if it’s to sell your home. One popular solution is to split your loan into fixed and variable amounts for peace of mind with the flexibility to make extra repayments or redraw funds if necessary. 

Make extra repayments

If you have a variable rate mortgage, then it’s a good strategy to use any extra savings or lump sums to reduce your loan while rates are at historic lows. 

You can tip this money into an offset account where it will reduce the interest you pay, but this only works if you’re disciplined and avoid the temptation to dip into your offset account for everyday spending. You may be better off making additional ongoing or one-off loan repayments; they will still be available for a rainy day if you choose a loan with a redraw facility. 

Catch the rising tide

There’s a flip side to all this. If you’re a pensioner or dependent on investment for your income then higher rates can’t come soon enough. And if that’s the situation you find yourself in you can read more here.
 

Speak to an Equip Financial Planner about your home loan and how it fits into a broader retirement strategy. Book an appointment online or call 1800 065 753.

 

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