Let’s have some straight talk on interest rates. Granted, the Reserve Bank has not lowered rates since last May, but all that has done is delay the inevitable. Given the current upward surge in the Aussie dollar it’s an odds-on bet that the trend will continue downwards, with more rate cuts in the short to medium term.
There has been a lot of speculation about the direction of rates in the United States, but the essence of all the noise has been that rates will either stay where they are, or rise by just 25 basis points. Such a tiny rise would be nothing in the scheme of things – all it would do is send a signal to the world that the American central bank believes the economy is making a strong rebound. Right now the evidence of this occurring is doubtful at best.
So what do you do if you’ve got a home mortgage now? One of the scariest statements I heard last year was in early December – it was from a TV commentator who said “homeowners were praying for a cut in rates to give them a present for Christmas”. Get real – if you’re having trouble coping with interest rates at record lows, where do you think you’ll be living when they start rising again?
The present low rates are the gift that keeps on giving, and borrowers now should be celebrating the fact that they’ve got a once-in-a-lifetime chance to really make a dent in that mortgage.
You need to understand the way numbers work. At a rate of 5 per cent, a loan of $100,000 would require repayments of $537 a month if the term were 30 years. However, if rates rose to 8 per cent, the monthly payment for a 30-year term would be $734. The problem with a 30-year term is that you are maximising the amount of non-deductible interest you are paying – the good news is that at current low rates of interest it doesn’t take a big increase in repayments to save a packet.
For example, if Jack and Jill have a $400,000 mortgage at 5 per cent that they are repaying at $2148 a month over 30 years, the interest over the life of the loan would be a staggering $373,000, even at such a low rate. If rates rose to 8 per cent, they would have to increase their payments to $2936 a month to maintain their 30-year term. Even if they could manage to do this, they would end up paying $656,000 in interest, which is 50 per cent more than they borrowed. However, if they were financially savvy, they could pretend interest rates were at 8 per cent now and repay $2936 a month. If rates stayed at 5 per cent, they would cut the loan to 17 years and save $181,000 in interest. Not only have they given themselves the potential to save a small fortune, they’ve also given themselves a valuable safety buffer if interest rates start to rise.
What about investors? There have been a lot of scary headlines recently about the banks putting up their rates by possibly 50 basis points, and speculation about what this might do to property investors. That’s nonsense – for starters, the interest is tax deductible for an investor, which takes the sting out of it, and to go on with, 50 basis points is not going to be a deal breaker. Think about it: if you suddenly discover a terrific investment, do you really think that even a 1 per cent increase in the price of your finance would stop you buying it?
Interest rates are now at historic lows and no one knows when the cycle will turn. But, as always, the key to making money is to buy quality investments at the right price.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: email@example.com
Read more: http://www.theage.com.au/money/low-rates-provide-great-chance-to-pay-off-mortgage-faster-saving-on-interest-20160323-gnpk9p.html#ixzz44G3vdS79
Follow us: @theage on Twitter | theageAustralia on Facebook