Posts

How do interest rate changes affect you?

For many Australians, a rise in interest rates will mean increased repayments on mortgages, loans and credit cards. With less disposable income, many people may need to tighten their belts.

Interest rate rises can be tough for families and small businesses, as increased mortgage and debt repayments can make life more difficult and expensive. While lower interest rates can mean a respite in terms of lower debt repayments, or provide an opportunity to get ahead on your mortgage.

When reviewing your finances make sure you look at how interest rates are tracking and if necessary, build in a buffer for further increases that might affect your repayments. It may also be worth looking at consolidating your debts and renegotiating your current interest rates to protect yourself from future increases.

The below summarises some of the economic consequences of interest rate changes.

Increase in interest rates

  • Increases the cost of mortgage interest payments
  • Reduces personal disposable income
  • Increases incentive to save rather than spend
  • Strengthens the value of the Australian dollar
  • Reduces consumption and investment

Decrease in interest rates

  • Makes mortgage interest payments more affordable
  • Increases personal disposable income
  • Encourages spending
  • Weakens the value of the Australian dollar
  • Encourages investment in property

Interest rates rises are generally good news for people with savings. For those looking to invest in term deposits or bonds, an increase in interest rates will generally mean higher rates of return. Term deposits usually offer higher returns in a rising interest rate environment and lower returns in a falling interest rate environment. This is the reason investors may hold a diversified investment portfolio including asset classes, less sensitive to immediate interest rate changes.

With the interest rate rises, you may want to consider reviewing any home or business lending. Talk with us today to discuss how the interest rate changes impact your financial situation.

Homing in on retirement

Pick an Australian, any Australian, and chances are they dream of buying a home or upgrading the one they already own. There’s the emotional satisfaction of knowing you own the roof over your head, the freedom to rip up carpets and keep a pet, and the stability it offers as you raise a family. But home ownership also has a role to play in retirement planning.

For most of us, the long-term goal is to retire with a home fully paid for and enough investments both inside and outside superannuation to support a comfortable lifestyle. What is less well understood is that the better you manage your mortgage and other debts along the way, the more money you will have for income-producing investments to fund your dream retirement.

Spending too much on renovations or buying in the wrong location are common mistakes that may potentially reduce your retirement income. Moving is costly and if a renovation doesn’t add value then it is money that can’t be recouped if you decide to downsize later in life.

The right loan
The loan you choose can also make a big difference to your retirement nest egg. Interest rates may be at historic lows, but there are big difference in the rates available from different lenders so it pays to shop around. If you already have a mortgage, ask your lender for a better deal. More often than not they will reduce your interest rate to keep your business, which saves you the cost of refinancing.

It also pays to think about the type of loan you choose. While interest-only loans often make sense for investors, they can be an expensive choice for owner-occupiers even though on the face of it they appear more affordable.

The catch with this type of loan is that without any repayment of the loan principal, interest-only borrowers are continually paying interest on the full amount of the loan.

The Australian Securities and Investments Commission (ASIC) recently crunched the numbers and found that on a $500,000 loan at 6 per cent, making interest-only payments for just five years can add $37,000 to the long-term cost of the loan.

Once again, that money could be earning compound interest in super and bankroll some memorable travel experiences in retirement.

Tax efficiency
Tax also has a role to play when it comes to managing your housing debt for the best retirement outcome. While your family home is generally exempt from capital gains tax, the favourable tax treatment of the family home does not extend to your home loan.

Unlike investment loans, your mortgage is not tax deductible so paying down the mortgage and freeing up money for investment is an important step in your retirement planning. However, the best place for your surplus cash may depend to some extent on your marginal tax rate.

For people on high marginal tax rates, salary sacrificing into super may be more effective than paying down debt. That’s because pre-tax contributions are generally taxed at just 15 per cent rather than your marginal rate. This strategy is even more effective when investment returns are higher than home loan interest rates.

For people in lower tax brackets it is generally preferable to pay down debt first and reduce interest costs.

Home and hosed
The closer you get to retirement the more important it is to be debt free, especially if your resources are limited.

Unless you rent out a room or enter into a reverse mortgage – a product that has never really taken off in Australia – your home won’t produce any income in retirement. So a balance needs to be struck between the amount of money you sink into your home and the amount you direct into income-producing investments.

If you would like to take a more holistic approach to your retirement planning, including the role of your family home, give us a call.