If you’re worried that interest rates might soon shoot upwards, taking stock of the bigger picture may reassure you
It’s every mortgage holder’s worst nightmare: what if interest rates return to the mid-teens, as we saw in the early nineties? The good news is that scenario is highly unlikely to occur, and there are steps you can take now to protect yourself if it does.
Despite our current low rates, when you look around the developed world Australia’s cash rate – the official rate set by the Reserve Bank of Australia (RBA) as a benchmark for lending and deposits – is relatively high.
And if the RBA’s current 1.5% target sounds low, consider the United States’ central bank, the Federal Reserve, held its equivalent rate between zero and one-quarter of a percentage point for nearly seven years in the aftermath of the global financial crisis.
Markets crashed – and rates followed
Thanks to the 2008 meltdown in financial markets that started in the US and spread quickly to the rest of the world, it is far cheaper to borrow money today than ever before. The flip side is that returns on deposits are low, making real estate an even more attractive investment.
So if you’re concerned that rates might rise, be aware that they also could fall (although a substantial fall is admittedly less likely). If you’re in the property market, or planning to be in it, there’s plenty you can do to make sure you’ll be ready for whatever changes come, but the principles are simple – do your sums, and make sure you leave yourself some financial breathing room.
A few rules to follow
One handy yardstick is that your repayments should be no more than one-third of your take-home pay. To take on bigger repayments means you should look at trimming expenses elsewhere or hope for strong capital gains when you sell your property.
Another approach is to make your regular payments bigger than the minimum required. In effect, you’ll be paying off your loan as if its rate was higher than it actually is. You can invest the extra amount you’re paying in, or offset it against your mortgage as a buffer against any rate rises.
Another strategy may be to consider a shorter-term mortgage. The advantage is that a loan’s principal (as a percentage of payments) increases as the total length of a loan is reduced. In that case, more of the loan will be repaid when there are low rates. If rates rise and it’s time to refinance, the principal will be smaller than it would otherwise have been.
If you’d like to lock in the benefits of our current low rates, or just want to make sure you’ve got the right deal, why not check your options today?
Do you remember when interest rates were in the teens? Have you been able to take full advantage of our low-rate environment? Tell us about your experiences in the comments below.
This post was updated to reflect the RBA’s decision to cut rates on 2 August 2016.