Article by Patrick Lynch, Head of Operations
For many readers with home or investment loan debt, or thinking about a property purchase, the answer to the above question is a resounding ‘YES’. And that’s good for you because yesterday (04/06/2019) the Reserve Bank of Australia approved a 0.25% cut in the official cash rate, from 1.50% to a new record low of 1.25%. This should mean more cash in your pocket (depending on Bank and Lender action). But do you know:
- How interest rates work?
- Why interest (and assessment) rates are falling?
- What effects, positive and negative, could this have?
- What to do with the extra money?
Many countries have independent Central Banks (e.g. the Reserve Bank of Australia) assessing the strength and performance of the economy. Interest rates are one of the tools available to stimulate (or slow down) an economy. How changes in interest rates work (all other things being equal) are:
- An increase in interest rates takes cash out of the economy, due to higher loan repayments or people choosing to save rather than spend. Less money going around has a depressing effect on demand for goods, services and property, cooling markets.
- A reduction in interest rates acts the opposite – more money in your pocket, with a disincentive to save, leads to spending and (hopefully) economic growth.
The RBA cash rate was 4.75% in October 2011 (and 3.25% 12 months later). It had been at 1.50% since August 2016. Understandably, the rate fell during and shortly after the Global Financial Crisis in an attempt to drive growth. Possibly, this availability of low interest rates (and easy access to funding) was a factor fuelling the booming property market in the years up to early 2018.
Why has the RBA reduced interest rates? The property market is generally acknowledged to have declined in the last 12 months, particularly in Sydney and Melbourne. There are also concerns about stagnant wage growth, low inflation and a heightened unemployment rate, all of which have fed into drab economic performance. The official cash rate is now 1.25% and most commentators, including the RBA governor, expect at least 1 more 0.25% cut by the end of the year. There are some economists suggesting the RBA will cut TWO MORE times before end 2019, i.e. by 0.25% each to a floor of 0.75%.
So how does this rate cut mean more cash for you? Well, most Banks and Lenders track their loan interest rates against the RBA’s official cash rate (as well as wholesale funding costs). In theory, a lower cash rate should lead to Lenders reducing the variable mortgage interest rates for existing and new borrowers. A lower rate equals a lower repayment equals more money in your pocket.
We’ve also seen regulators getting involved in an attempt to stimulate growth. These are the same regulators who, a few years’ ago, put a cap on investment loans provided by Banks, moved to restrict property purchases by non-residents, and warned of the dangers of interest only lending and assessment of living expenses. Most of these restrictions have been removed, but the property and lending markets are still slumped. So APRA (the Australian Prudential Regulation Authority) has proposed a reduction in assessment rates used by Lenders, i.e. rather than use a rate of (say) 7.25% to address a borrower’s repayment capacity, it is suggested to use actual rates plus 2.50%. This could improve borrowing capacity.
And what are the Banks and Lenders doing? In September 2018, due to sustained increases in wholesale funding costs, 3 of the Big 4 Banks increased their interest rates (smaller Lenders having done so previously). We’ve recently seen these same institutions independently reduce rates to try and generate demand for lending. This is on top of sweeteners offered for refinancing (rebates of up to $3,500) or purchasing ($2,000).
With interest rates falling to record lows, is this great for anyone with or thinking about borrowing? From an assessment and cash flow view, definitely. Lower rates mean less of your money being spent on loan repayments. More prospective borrowers are going to be able to access credit. This could stimulate economic growth, leading to stabilisation and regeneration of the property market.
This depends on whether the RBA rate cuts are passed on to borrowers. We’ve seen the Big 4 Banks make their announcements on their standard variable rates, surprisingly with some deviations:
- ANZ – passed on a 0.18% cut, effective 14 June 2019
- CBA – passed on the entire 0.25% cut, effective 25 June 2019
- NAB – passed on the entire 0.25% cut, effective 14 June 2019
- Westpac – passed on a 0.20% cut (with 0.35% for variable residential investment property interest only loans), effective 18 June 2019
The non-major Banks and Lenders are also announcing, although some may need a few more days. This is on top of recent movements in fixed rates, e.g. NAB’s First Home Buyer special rate of 3.49% per annum, fixed for 2 years. As with ANZ immediately after their response to the RBA rate cut, anyone who doesn’t pass on the full cut will come under media and government pressure. With another cut in the RBA cash rate likely later in the year, the Banks and Lenders will have further interesting decisions to make.
Lenders have had to be aware of their depositors and investors. For depositors/ savers, who might be more focused on return than loan rates, the Banks may reduce the deposit interest rates. Deposits are a source of cheap funding for Banks, as opposed to the wholesale market, and lower rates could see an outflow of cash. Lower rates can also mean lower profits, which can be bad for investors holding shares (direct or via Super) in the Banks – lower share price, dividends, etc. Although historically share markets tend to react positively to RBA rate cuts, which reduce corporate borrowing rates and improve consumer confidence, with savers chasing higher returns from shares.
But there is no guarantee that lower rates work to stimulate an economy. The economic impact of the RBA’s adjustment may be marginal and could unintentionally be seen as signalling weakness internationally, e.g. the AUD exchange rate might weaken, making oil prices higher and being less beneficial for overseas cash. Think back also to the GFC, when many countries were in recession. Most went down the same path as Australia (who never technically entered recession) – reducing the official rate in an attempt to stimulate the economy. When that didn’t work, they tried to use other monetary policy tools such as Quantitative Easing (increased money supply).
- Europe has effectively had a ZERO cash rate and been charging banks for depositing money with the European Central Bank (i.e. negative interest rates for savers) for at least 5 years.
- Japan has had negative interest rates for years.
- It appears only the US economy has progressed from low rates – they began increasing their official rate during 2017.
If you end up benefitting from lower rates and loan repayments, what should you do with the extra cash? The tempting thing would be to spend, spend, spend – this is why the rates are being cut, to drive spending and growth. But you may want to consider maintaining your repayments at the original level, especially if you have home loan debt and can afford to do so. This will result in quicker paydown of your loan as well as create equity in your property. Redraw, or accepting the lower repayments but putting the savings into your offset account, will also allow you to access the cash for a rainy day or benefit from future opportunities. Ultimately, everyone’s circumstances differ – what might be right for you, may not be right for some.
To discuss any of the above or your lending needs, please contact myself or Dan and we will steer you in the right direction.
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