| 1. So what's the deal with interest rates? So.... interest rates are going up constantly at the moment and we have just recently received our 11th straight increase, the first during a federal election campaign. Now, while these points are all true, there are many other ways to look at rate rises, which will enable us get a better overall view of how this event will impact you. Here are a few thoughts to ponder: Does anyone actually pay the standard variable interest rate quoted extensively in the media of 8.67%? The vast majority of borrowers receive a discount of 0.5 to 0.7% off this benchmark rate as part of their "professional package". Most lenders offer professional packages to borrowers with loans above $150,000. Now, if you have a mortgage below this, a rate rise will likely have smaller comparative impact than if you had a $600,000 mortgage. It is all relative! Using fixed rates should be encouraged. If you are close to "the edge" and any further increases in rates could tip you "over into default" you may want to consider fixing the rates in. Now many pundits (and mostly those not in this personal situation) will say that: Fixing rates Fixing rates in is not sensible because they are a lot higher than variable rates. This is just NOT TRUE! At present the discounted variable rate of 8.09% (for most lenders) is the same or only marginally lower than most 1, 2 and 3 year fixed rates. You cannot use an offset facility to save interest when using FIXED RATES this is true. If however, you are that close to the edge, you're not likely to have a substantial amount in the offset account to generate substantial savings. Some banks even offer partial offset accounts on fixed loans up to about 3%. In this case you are probably better advised to open a high yielding account to park your spare cash in. If you have some spare cash and really want to hit your loans hard. You can pay up to $15,000 in extra repayments while fixed without penalties on fixed loans.
If you are in the situation of feeling "the pinch and likely to default on your loan repayments" you are unlikely to have more than a "spare" $1000 per month to pay into your mortgage anyway.
You will lose out if you fix your rates. Historically rate movements have been in favor of variable rates. However, it all depends where you "entered the interest rate curve" and fixed your rates in. Those who fixed 2 years ago on rates in the mid 6% range would be feeling happy with themselves at present when they look at the current variable rate. The current rate rise of 0.25% may well be higher once it comes to you in your statement in a few months time. This is because a few of the major banks have been making rumblings about the higher cost of financing their loan books (due to the meltdown in the US Sub Prime market flowing to other credit markets) and they may well raise rates higher than the RBA induced 0.25%. Fixed rates at one of the big four rose twice in the past month prior to the RBA announcement - did they know something we didn't? The simply answer is NO. The banks have no "inside knowledge" of potential rate rises but are simply responding to a rise in the cost of funds in the long term bond market which is simply reflecting the marketplaces belief that rates in the next two to three years will be higher than now and that the market has been very volatile of late. When you go out of a fixed rate to a standard variable rate the jump in a rising interest rate environment can be quite severe. One way to handle any fallout from such a move is to pay the current variable rate repayment on the loan even though your rate is fixed in. This way when you transition from a "fixed 6.7% rate to a variable 7.97%" you are ready for it. And a final point is to keep this all in perspective as to why rates are rising. The Reserve Bank is responding to an inflation rate that is tracking at a level at the high end of its 2 to 3 % acceptable band. This higher inflation rate is due mostly to the impact of a booming economy - almost full employment, favorable international export markets and massive capital spending. The "forces of supply and demand" are getting out of kilter and the RBA is worried that we will see an unsustainable bout of inflation. When inflation threatens to move our of "the band" the RBA applies the "blunt instrument" of monetary policy (i.e. higher or lower interest rates) to impact on the demand side of the equation. It is trying to apply "the brakes" to a rapidly expanded economy so that it will be able to "grow faster on average" over time with out "skidding off the road" into a severe bout of inflation or recession. Rate rises are painful, but not as painful as an inflation-induced recession! This information is an extract from the Hudson Newsletter. October 2007
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