Australian Interest Rates – A Double-edged Sword?

by Alexander Beard, on Aug 14, 2019 12:32:00 PM

Interest Rates

The official “cash rate” as set by the Reserve bank in Australia has reached an all-time low following it’s Rate decision in July.  The official “cash rate” (ie the rate charged by the Reserve to lend money to Banks) now sits at 1.00%.  The Reserve Bank has hinted, and economists agree, that further rate cuts are likely in order to provide economic stimulus.  At the same time the Reserve Bank Governor has stated publicly that the Federal Government needs to do more in it’s own right to provide economic stimulus (suggesting areas such as Infrastructure spend).

What does the interest rate environment mean to the average person?

The cost of borrowing money is at an all time low, with many “Banks” marketing that if your mortgage interest rate doesn’t start with a 3 then you should be leaving your bank and seeking an alternative. 

But low interest rates can encourage us to take on more debt, and that’s a problem because Australia’s household debt, relative to income, has been steadily rising for the past 30 years. Statistically, an average person earning $80,000 annually is spending close to $152,000. The only way this can be done is by borrowing money – and low interest rates coupled with an easing of lending restrictions make it easier to borrow more.

Worryingly though high levels of debt also leave us vulnerable to a slowing of the economy, particularly if the job market is affected. And there is no doubt that the Australian economy is showing signs of cooling.  Another change we’re seeing in household debt relates to the growing tendency for older home owners to carry big levels of debt and to take this debt into retirement.

The other side of the low interest rate issue relates to our need for our savings to produce income throughout our retirement (and to protect capital as a priority).  Historically, relying upon Term Deposits to produce income has been a reasonable strategy, high yields coupled with the “safety” of the Banks (not forgetting government capital guarantee on deposits under $250,000).  But low interest rates mean that the yield from these “safe investments” is not sufficient to meet income requirements and makes drawdowns on capital in order to meet income needs inevitable.

Potentially the situation arises therefore that high levels of debt are taken into retirement to be serviced by low yielding investments.

The Solutions

Making extra repayments on your mortgage is a simple way to clear the balance sooner and save on interest.  By leaving your repayments at their pre-rate cut level you can pay more off your mortgage and extinguish it sooner.  If you don’t want to lock cash away, a home loan offset account offers at-call access to spare cash while still reducing the loan balance.

This chart shows the returns on asset classes over time.

Chart

All investments come with some element of risk (loss, profitability etc).  A well-diversified and structured financial portfolio, that is based on the level of risk that you are personally comfortable with, can however increase the yield on investments.  Without taking unnecessary risk.  It can also take advantage of strategies that are tax effective (eg superannuation, dividend franking credits etc) further increasing the yield on investments. 

Contact your Alexander Beard Group Adviser if you wish to discuss effective financial strategies for your personal situation.

Your home may be repossessed if you do not keep up repayments on your mortgage.

Dave Stone
Managing Director - Australia

Topics:BankingBorrowingInterest Rates