On the back of the Reserve Bank of Australia’s cut in the official cash rate this week to 2.00% and continued speculation of lower interest rates - it is an opportune time to take heed of Mark Twain who told us although history doesn’t repeat itself, it does rhyme and jog our memories that interest rates are currently set at historically low levels.
Most people under the age of 40 won’t remember – but if we were to jump in a DeLorean time machine with Marty McFly, boot up the flux capacitor and take ourselves back to the future in 1991 – we would find the Reserve Bank’s official cash rate reached 18%. That’s right 18%!!! On a loan of $500,000 that would equate to $90,000 in interest payments each year. Fast forward to today with a standard variable rate of 4.25% you would only by paying $21,250 in interest. Now I don’t think we’ll see interest rates at that level again anytime soon (famous last words)…but it is worth remembering when you take out a 30 year mortgage where interest rates have been in the past.
You only have to go back to 2007/2008 to find interest rates above 7%. Since then interest rates have gradually been falling. Over the same period of time household debt has been increasing as house prices rise and people have become more relaxed taking on larger amounts of debt in a lower interest rate environment.
It is generally accepted that long-term interest rates average around 7% - much higher than the variable rates banks are offering today that are well below 5%. Even the National Australia Bank are getting into the “Back to the Future” act – with a recent radio advertisement tempting us with a variable rate that hasn’t been this low since 1978! Who knows what’s next…banks might even throw in a hover-board with a new loan!
Before jumping at the advice the Treasurer Joe Hockey gave potential borrowers this week of just "have a go" - we'd suggest a more prudent approach as part of an overall Financial Roadmap that will put you in a stronger financial position. And importantly look to stress test your financial position – particularly your ability to fund mortgage repayments at higher interest rates. This will give you the heads up on any corrective or pre-emptive action you should take on your cash flow and family budget in the event interest rates rise at some point in the future.
So if you’re considering taking out a loan to buy a home and unsure how much you can afford to borrow or simply want a sanity check over your existing financial position and debt levels we’d be happy to chat with you.