Interest Rates are Dropping. How Might This Affect You?

by Dominique Schuh

Well, it's finally happened. The Australian official interest rate was lowered to 1% last week. This is a new low that we perhaps never thought we'd see in this country, having been protected by our mining boom when most other developed countries were riding down the wave of the GFC 10 years ago. One commentator has asked whether Australians are now simply going through what the US and Europe went through 6 and 7 years ago, only on a delayed time frame? So, what will the latest interest rate cut mean for you? We've listed some relevant points to keep in mind:

For savers
These are the investors who will be feeling the interest rate drop the most. For a term deposit now, you'll be doing well to earn over 2%, which is particularly painful when inflation is running at 2.5%. If you haven't already, now is the time to consider adding additional asset classes to your investment mix and taking on some more risk.

For bond holders
Bonds (also known as fixed interest) are not dissimilar in nature to term deposits, but they can be bought and sold, which means the underlying price of the bond can change. When interest rates are falling it's normally a good thing for bond holders, as the price of the bond will increase and therefore the overall value of the bond will go up. When interest rates rise, however, bonds will tend to behave in the reverse manner and the underlying value of the bond will drop for a period of time until an adjustment is made towards the higher yield (income) that the bond will generate. A good rule of thumb for bonds is to aim for a return of between 1.5% and 2% better than the cash rate, provided the bond term is around 5 years. A shorter-term bond can actually perform better when interest rates are rising.

For mortgage holders
If you have debt, this is your chance to get ahead and you should grab it with both hands. Contact your bank and ask for a mortgage review, as a typical variable home loan should now be costing you well under 4%, ideally closer to 3.65%. The real key is to keep making the same repayments during this time and more of your repayments will go towards actually paying off your loan balance and less will go towards paying the interest component. Also, be aware of the temptation to borrow more while interest rates are down. At some stage, they'll come back up and if you haven't done the work to reduce debt while rates are so low, you'll be in for a rude shock when they're higher.

For property owners and investors
Money and capital will always flow to the areas where it can receive a better rate of return for a certain amount of risk. When interest rates drop, it's not uncommon to see money poured into the property market if people have been sitting on cash for some time. And while most property investments will give you a better return than you would receive from leaving money in the bank, the rental income has also come down over time. For example, a commercial property once returning 9% income is now more likely to be returning around 5%. This is still superior to the cash rate.

For share investors
For those who invest in shares, we're now seeing the income generated by dividends as being at a higher rate than bank interest. This is historically unusual, but the income generated by shares (particularly when franking credits are included) can be very attractive to investors. Of course, share values can move up and down on a daily basis, but a large degree of spread across your share mix will help to smooth your ride. Initially, the share market has gone up after the interest rate drop as investors have diverted money into buying more shares, looking for a better return than bank interest.

The interest rate drop can be seen as both a blessing and a curse, depending on your personal situation. If you'd like to discuss how to make the best use of the rate drop, please don't hesitate to contact us. We're only a phone call or email away.