Making the most of low interest rates

Banks have not been passing on the full reduction in the Reserve Bank’s official cash rate, but no one knows with any certainty, what the future holds for rates and to what extent.

Most predictions are that they will remain at the low end for some time to come, so while borrowers love low rates and savers curse them, what can be done to make the most of the situation?

Yay!

Major winners of low interest rates are households with mortgages that were taken out at a higher rate. Keeping up repayments at the original level will see the mortgage paid ahead of schedule, delivering a big reduction in the total interest bill.

Property investors can also be winners, particularly when buying property away from the high prices and low rental yields of inner capital city areas. However, care still needs to be taken to avoid excessive debt that could have a disastrous effect when rates rise.

Businesses benefit from a low and stable interest rate environment. It’s cheaper to borrow to grow the business; and a major reason why the Reserve Bank lowered interest rates to stimulate business investment.

Boo!

For everyone cheering on low rates there will be someone booing them.

People who depend on term deposits, high-interest savings accounts and bonds have seen their interest income fall by more than half! Self-funded retirees are particularly affected, especially where interest payments make up most of their income.

Low rates aren’t always the friend of new entrants into the housing market as commonly touted. Low interest has been a major contributor to the rise in house prices, saddling new borrowers with higher levels of debt. With higher debt, any future rate rises will bite harder, so new borrowers need to carefully assess their ability to meet loan repayments when interest rates do rise. It’s also a good idea to reduce debt whenever possible.

Life is also difficult for investors, including everyone contributing to superannuation. The low yield from conservative investments (cash and fixed interest) means there is a greater ‘cost’ in minimising portfolio risk than has previously been the case. One consequence of this is to drive many investors to search for other investments that offer higher cash returns at a potentially higher risk.

Looking for yield

While a bank share paying an annualised 5.83% dividend (including franking credit) looks very attractive beside a term deposit offering 1.70% interest, it needs to be remembered that, in the current climate, any effort to increase yield comes with an increase in risk. Even so, high yield shares can be a viable option for some investors who need a regular income.

What to do?

The best way to navigate the world of low interest rates depends very much on your personal circumstances. Good advice is critical, so talk to us about your situation.

This is general information only