It's time to review your loan rates
The prospect of faster-than-expected US interest rate rises and threats of a trade war in response to selected US tariff increases have unsettled world sharemarkets and increased investor uncertainty. With the world economy still performing strongly, the sharemarket falls could still be an overdue healthy correction from high levels rather than an indicator of worse to come.
Higher interest rates pose a more serious threat to geared investors and consumers, particularly those with owner-occupied mortgages not eligible for a tax deduction for interest expenses. For many reasons including the high-level of indebtedness of Australian households and a strong dollar, the Reserve Bank is likely to be slow in raising official cash rates.
Nevertheless, a crackdown on interest-only loans and tighter bank lending conditions have slowed investor demand for properties causing prices to weaken. Higher borrowing rates have an immediate impact on variable interest rate loan borrowers. Borrowers can opt for fixed interest rate loans for periods generally ranging from one to five years. Unlike in the US where financial institutions generally offer fixed rate mortgages for periods up to 30 years, our lenders prefer to place the risk of interest rate rises on borrowers.
Given the potential adverse impact of rate rises on the property market, borrowers face two decisions to protect themselves. First, while interest rates are still low and relatively attractive, will changing to a fixed-rate mortgage for as long as five years reduce their risks? Second, is the time right while conditions are still favourable to reduce their debts by selling the property or paying off the loan more quickly?
Heavily indebted borrowers with existing loans have only themselves to help assess whether they are overcommitted even if interest rates rise marginally by 1-2 per cent. But without knowledge of the risks involved, they face the possibility of penalties and even forced disposal if their account falls into arrears.
The time to take tough decisions including with poorly performing or ill-advised negatively geared investments is when markets are still strong and interest rates low. Warning signals are already flashing in some apartment markets with extended settlement periods and guaranteed rental yields for several years being offered. Such offers indicate a struggling market and potential problems for purchasers. Now is the time to review existing loan commitments if interest rates rise as they inevitably will.