Best way to cope with rate rises
Tighter regulations and slowing credit growth are forcing financial institutions, including Westpac and Suncorp, to increase their variable interest rates. These increases come when the drought and aweakening property market are reducing the prospects of continuing growth in key sectors of the economy.
As a result, the Reserve Bank has been reluctant to increase the official interest rates from the present historically low levels to more normal levels. With rates rising offshore and continuing political uncertainty, the cost of overseas short-term funding for our major banks has increased.
The increased costs arising from the regulatory charges and the ongoing banking Royal Commission have also helped trigger the variable interest rate increases.
The prospect of major changes to the taxation of property investors isn’t helping investor confidence. But for those contemplating new borrowings the tightened regulations are limiting the amount that can be borrowed as well as lengthening the time needed for loan approval.
Both factors have been restricting the ability of potential purchasers to acquire properties and for vendors to achieve good prices. Given the importance of property construction to continuing strength in the economy, the Reserve Bank is unlikely to add to developers’ problems by increasing the official interest rate.
If anything, the Reserve Bank will face pressure to reduce the official rate to help the banks and property sector. The increase in interest rates for borrowers has been relatively small and can be financed in some cases by reducing repayments of principal.
One major bank has already responded to the slow down in credit growth by informing existing clients about the possibility of reducing their minimum monthly repayments. However, taking advantage of this option increases the risks of being adversely affected by any future rate rises. Indeed, the current interest rate increases are a warning that further increases are possible. Continuing to repay capital as quickly as possible is a way to reduce risks and build wealth even with investment loans where the interest payments are tax deductible.
Not paying off an investment loan makes excellent sense when there’s also an owner-occupied home loan in existence. In this case, paying off the home loan first reduces non-deductible interest outlays. When the only loan is an investment loan, paying off the principal still makes sense.