I’m sure you have been following the economic news and now know that last week the Reserve Bank of Australia lowered official interest rates to a record low of 1.5%. Of course that’s not the rate at which you can borrow, which will be 2-4% higher (the banks margin) or the rate at which the bank will pay you for your savings – currently anywhere from 0% to about 3%, depending on the length of time you loan your money to the bank and how much you loan. Yes, your deposit to the bank is a loan from you to them – your deposit is actually a liability on the bank’s balance sheets and that is because it is your money and at some point you might want it back.
Let’s assume that you are either already an investor or you want to be one, having the lowest interest rates on record is a major benefit. That is simply because the cost of borrowing money is lower than it has ever been. The Government and the Reserve Bank have decided it would be a good thing if you were encouraged to borrow a bit more and then spend that money on whatever it is you want, since that has an economic multiplier as you consume goods. Yes, it is good for our economy if you are spending.
Our banks however have a different agenda. There is no legal compulsion for the banks to pass on any interest rate cuts. Our recently re-elected Prime Minister came out and wagged his finger at the naughty banks, who predictably did not pass on most of the last cut to the consumers. In fact they have taken advantage of the lack of variety of lenders out there, caused by the effects of the GFC, to increase their loan margins almost every time an interest rate cut has been announced over the last few years. This has made them much more profitable and paradoxically has made the banks stronger, which means the chance of a financial meltdown or more financial restrictions has lessened. The bad news is that you & I, as borrowers are paying for the increased strength in our financial system.
The recent 0.25% rate cut would be equivalent to a saving of about $17 per week on an Australian average $357,200 home loan. But since the banks are only passing on about half of that, the saving will only be around $9 per week. Doesn’t sound like a lot but if your maintained loan repayment at current levels instead of reducing it by $9 per week, you potentially could save more than $20,000 in repayments over the life of an average sized 30 year loan.
So yes, I think you should be interested in interest rates.
However there are plenty more reasons why you should.
The banks have adopted an interesting position with the failure to pass on the full cut of 0.25%. They tell us on one hand that they want to shore up their balance sheets, and on the other they can report increased profits to their shareholders. And that is fabulous if you own bank shares. The interesting thing is that what some of the majors have done is not pass on the full cut to borrowers while increasing the rate they will pay savers. They are clearly trying to attract more of you to deposit (loan) your money in to their respective banks. The more money they can raise locally, the less they have to borrow on the increasingly fickle and difficult overseas money markets. It actually makes good economic sense. They know that international regulations are coming next year that will make their capital raising from overseas markets more challenging and likely more expensive.
And it is also possible that the amount of lending might be curtailed even further if the banks have challenges raising the money they need so they can onlend it to you. The Government won’t want to see this as it will mean that you as a consumer may not have the funds to go out and buy stuff to make the economy go round. The Government may then need to increase its spending on infrastructure or other employment producing projects. That could mean higher taxes or higher deficits and more government (our national) debt. Neither option is particularly attractive.
So while some of us might like to grumble at the banks, funnily enough, they are probably doing the right thing – assuming of course that they are able to maintain their rates of lending through these on-the-face-of-it greedy policies.
While my crystal ball is a little cloudy and no one can really be sure, as I look out a few years I can’t see any immediate reason for interest rates to rise, in fact the opposite may still occur – I am expecting another 0.25% cut before the end of this year. For rates to rise, the real estate markets need to be soaring and the economy, wages & inflation to be rising fast. This isn’t happening. Our Australian dollar remains stubbornly higher than our Government & Reserve Bank wish it to be – a great way to lower its value is to have lower currency yields – and that means lower interest rates. Our currency still looks attractive to overseas investors because the other major currencies like the USD & the Pound all have interest rates at near zero. And we are still relatively much higher than that.
So if interest rates for the foreseeable (cloudy!) future are to remain at lows or perhaps even go lower, what should any prudent investor or wealth builder do?
That really depends on you and your investment plan. These extraordinary times have given you or could give you some extraordinary chances to really grow your wealth.
There are two major strategies for you to follow. And a third which is a hybrid of the first two.
First, use these low rates to make big inroads in to your borrowings – that is, pay down any of your debt as fast as you can, starting with the highest interest rate debt first. While the cost of money is low, you can reduce debt faster.
Second, is actually the opposite of the first. You could choose to gear up to the maximum possible borrowings that you can reasonably and safely afford and buy some quality real estate assets. At around 4% or so borrowing rates, if you are careful, you could be purchasing property that pays for itself from Day 1 through the rental returns. Why not borrow to buy quality real estate assets when it is cheap to do so? What you may need to be careful about is that inevitably, at some point in the (cloudy!) future, interest rates will rise again – you don’t want to be caught with debt you can’t afford.
Third, you might decide to work a combination of the first two strategies. You could work to pay off your home loan debt, which is non-deductible and take on some new investment debt which is deductible via negative gearing tax benefits.
If this third strategy is interesting to you, I invite you to listen to our next Radio Wealth Podcast, which outlines one of the most brilliant loan structures that I have seen in over thirty years of investing. You will have the opportunity to set up specific loan structures that attack the loan component on your own home (the one you live in) while maintaining the deductibility side of your investment loans and the subsequent tax benefits. This podcast will be ready in the next few days and I can tell you I am really excited to share this with you.
The most important thing for you as an investor is to be aware of the changing circumstances in the economy and adjust your investment plan to suit. Interest rates – the price of money – which is critical for us as borrowers is a major component in our wealth plan.
And if more borrowing is not possible for you, but you still want a piece of the real estate pie, then investing via Brickraise, from as little as $5,000 for returns in excess of 10% is the next generational way of real estate investing. Check it out here.