The future of interest rates
There are many factors such as international markets and events that affect interest rates today and what what interest rates will do in the future let alone domestic factors, so forecasting rate movements is an inexact science.
In my view and that of most economists we are likely to see at least one more drop in the RBA cash rate by 0.25%, possibly as soon as next month but almost certainly before the end of this calendar year. A further 0.25% cut could follow, although this is less certain. We may then see a period of stability with the next movement more likely to be up before the end of 2016.
What is not in doubt is that we are already seeing rates in unchartered waters with at least one lender at the date of writing offering a 3 year fixed rate of 3.99%!
As always, the Reserve Bank has a delicate balancing act on its hands. They would like to cut rates to help devalue the Australian dollar to make our exporters such as our miners and farmers more competitive, particularly as commodity prices have slumped. However, anyone trying to buy a property at the moment in Sydney will tell you how hot the market is and the Reserve Bank is conscious of not wanting to provide even further stimulus.
Just as an example, I had a client looking to buy an apartment in Sydney’s inner West that had an initial price guide of $680,000 that went for $830,000 at auction and this is by no means unusual with auction clearance rates around the mid 80% mark. But, (and it’s a big but) this property market trend is not uniform across Australia, let alone NSW.
What is for sure, with rates as low as they are, borrowing more and more is becoming very cheap. It will cost a home buyer less than $10 per week to borrow another $10,000, hence the ability to pay more for a property provided the bank will lend you the money is significantly increased and this factor is pushing prices up.
If you are a home owner
There has never been a better time to pay down your loan as much as you possibly can whilst rates remain low. Every person’s circumstances are different, but as a general rule, you should pretend that rates are at least 7% and make repayments based on that level; if you can afford to pay more, then great.
If you are looking to buy
One of the great dinner party conversations at the moment is what will happen to the property market. Is it a bubble or not.
Because property is far more illiquid than shares in the share market (that is generally harder to sell quickly and can’t be sold in part) you need to buy with a long term view. I’m not a proponent of there being a property bubble in Sydney, but that is not to say that the market may not stabilise or perhaps even go backwards by 10% some time in the next 3 to 5 years.
In my mind, if you are buying a property now, you need to have the view that you will hold that property for at least 10 years so you can ride out any slowdown in the market.
I am a fan of property investment as a great way to build wealth, but you must have a long term view, particularly given the state of the market and the expensive entry costs, primarily stamp duty.
There are a few signs that a readjustment in the Sydney property market will occur. I have seen apartments in Sydney selling for around $750,000 that rent out at around $550 per week. That is a rental yield (before taking into account managing agent’s fees) of 3.8% which is below the long term average. There was an old rule of thumb for entry level properties that you should get $1.00 of rent per week for every $1,000 in property value. In the above example, that would be $750 per week in rent, not $550 that is on offer.
None of this is a reason not to buy now, just the need to exercise caution to be sure that you can hold the property for long enough to ride out any market bumps along the way.
By the way, don’t try and pick the market’s high or low points – for the vast majority of home owners and property investors, you must have a long term investment horizon.
How much can I safely borrow?
This is a very individual question as it will depend of what assets and liabilities you have as well as your income and expenses. This is where you really do need to see your accountant and professional mortgage broker to assist you.
What I will say is whatever you intend to borrow, do your affordability assessment based on interest rates being 2.5% higher than they are now as you need to allow this buffer if rates, as they may do in the long term, rise to long term averages.
Should I fix my interest rate?
There is not a one size fits all answer to this question. With rates as low as they are, it is likely to be a very sound strategy to fix at least part of your loan, particularly if you are borrowing at levels that will test you if rates increase. This strategy will give you certainty and de-risks your future expenditure.
Be aware though that generally that part of the loan that is fixed will not have an interest offset account associated with it that can be used where you can “park” any spare cash that you have to reduce your overall interest cost.
For this reason, it is usually a good idea to keep at least some of the loan on a variable interest rate basis so that you can take advantage of an interest offset facility for at least that part of the loan.
Remember too that if you are forced to break a fixed rate contract, the break costs can be significant.
Finally, one thing to remember about fixed rates. In setting the rate, the lenders take into account how they think rates will move over the term of the fixed rate period. You will usually see fixed rates move upward once the sentiment for future rate movements is in in that direction. History tells us that once rates start to go higher as they inevitably will at some point, you will not see the sort of fixed rates we’re seeing at the moment. So if you’re thinking of fixing, don’t wait until variable rates start to move up as you may miss the boat.
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