Why interest rates will stay lower for longer
Despite the increasing concern of indebted borrowers about possible interest rate rises, continuing low inflation and a softening property market will ensure that even with likely rate increases overseas, Australian rates will remain low for longer.
At a macro-economic level, the Reserve Bank has recognised the mortgage stress that increases in interest rates to more normal levels would create.
More importantly, the Reserve considers that the Australian Prudential Regulation Authority's rule tightening has reduced the need for rate rises to slow down a buoyant property market.
Restrictions on overseas buyer purchases and an oversupply of apartments in Brisbane and parts of other major capitals has dramatically altered the situation of off-the-plan purchasers. Previously, the purchasers could be confident of obtaining loans at valuations close to their contract prices and have the option of selling their property for a profit before settlement date.
Now off-the-plan purchasers, especially those forced to settle, are facing a situation of selling at a loss or finding additional sources of finance. Interest rate increases would only exacerbate the problems they are facing in honouring contracts entered into in many cases one or two years ago when the apartment market was booming.
A continuation of Australian low interest rates when those overseas are rising would also help the economy by reducing the exchange rate because of reduced overseas investor cash inflows. Overseas investments would also be more attractive to domestic investors.
Low interest rates are, of course, not good news for domestic investors including retirees who since the global financial crisis have suffered from low returns because of historically low interest rates.
For borrowers, continuing low interest rates provides the opportunity to repay debts more quickly and, in the case of flexible mortgages, to build up redraw facilities or boost offset accounts. Given the tightened super-annuation contribution caps and the preservation rules tying super up untouchable until at least age 60, concentrating on reducing debts including investment loans is an attractive saving option.
When interest rates start to rise, the best protection will be to have sufficient cash reserves so as not to be cornered into a forced sale of assets in what could be deteriorating markets. When it is clear that servicing existing debts at higher interest rates would not be affordable, two options are available.
The first is to switch all or the bulk of the debt into fixed rate loans while rates are low. The second is to liquidate some or all assets while prices are solid. Investors are naturally reluctant to trigger losses, but when there's a possibility of even lower prices if rates rise, selling assets to reduce debts may be sensible.