11
May
2016

Interest Rate Risk

So what do we do about it?

It is no secret that house prices are extremely high at the moment and many average Australians are now carrying high levels of debt. We also have interest rates that are historically low so these debts are manageable for most. My concern is that these interest rates cannot possibly remain at these levels and when they increase will be able to continue to afford their repayments.

To demonstrate how interest rates will impact on cash flow, if we look at someone with a $500,000 loan, very common place in this day and age, for every 1% that interest rates rise, mortgage repayments increase by $5000 a year or nearly $100 a week.

Given that the long term average interest rate is a little over 7%, and many banks are offering rates in the low 4’s at the moment, it seems clear that the rates will rise, if they return to long term averages, that borrower above with a $500,000 mortgage will have to find another $15,000 a year.

It also stands to reason that if we are currently a few percent below long time averages, that at some point in the future we will be a couple percent above average. It is likely that at some point in the next decade interest rates will be around 9%, I wonder how many people with a $500,000 mortgage would be able to afford mortgage payments with interest rates at 9%, approximately $25,000 a year ($500 a week) more than they are currently paying.

So what do we do about it?

The first strategy is to lock in a fixed rate. At least you than know what your repayments will be for that period of time. 3 and 5 years rates are currently still less than 4.5% with many banks. Ive just locked in my rate for 5 years.

This has a disadvantage of restricting additional payments, if you intend to make additional payments, perhaps have a portion of your loan variable and make additional payments of this portion of the loan.

Another option is make additional payments, whilst interest rates are low and reduce your debt as much as you can so when the interest rates inevitably rise, you will have a lower liability and be less exposed to interest rate increases.

It might be worthwhile looking at any assets that you have that could be used to reduce your debts as interest rates climb.

 

The most important thing is to acknowledge that interest rates are likely to rise and be aware that for many interest rate risk is a significant consideration and should not be ignored 

Author; Alex McKenzie Categories: Future Financial Services Blog

About the Author

Alex McKenzie

Alex McKenzie

Owner at Future Financial Services

Past:

  • Paraplanner at Zammit Partners Investments
  • Unit Trust Administrator at Colonial First State

Education

  • University of Western Sydney
  • Penrith High

About

As a Financial Planner I help people to achieve what they would like in life. This involves helping you to identify the things in life they would like , developing plans to help achieve them and strategies to protect what you already have. We do this by providing Financial Advice to guide you through your life stages.

The financial planning process involves determining a clients current situation and financial objectives and tailoring strategies to assist in best achieving those objectives.

I am an expert in superannuation, investments and insurance, these are tools we use to help you achieve your goals.

I aim to use my knowledge of superannuation, taxation and Centrelink to efficiently use your assets and income to achieve your financial goals.

Retirement and pre-retirement planning, wealth creation, asset protection, insurance planning and estate planning are all areas of advice that I provide.

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