Interest rates have been low for so long it’s tempting to think low rates are the new normal. So when the Reserve Bank suggests that a cash rate of 3.5% is the new ‘neutral’, people take notice. Neutral is central bank speak for the sweet spot where growth is supported without pushing inflation too high.
The official cash rate has been held at a record low of 1.5% since August 2016, but in recent months the Reserve Bank has begun preparing the ground for higher rates. However, in a speech on July 26, Reserve Bank Governor Philip Lowe made it clear that rates will only rise once there’s a gradual lift in wages growth and inflation. As things stand, he’s in no hurry.
Wages, 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%.
So what can you do to make the most of today’s low rates and soften the impact of higher rates in future?
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 and an increase in interest rates would blow a hole in your budget, then think about 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
Higher interest rates are not all bad news. If you’re a saver or depend on income from investments, higher rates can’t come quick enough.
If you are concerned about the rise in interest rates don’t hesitate to contact your adviser or Adam at Endeavor Finance on 03 5434 7690.