Finance Your Budget How to make the most of record low interest rates

How to make the most of record low interest rates

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Australian interest rates are at record lows as the nation catches up with the deflationary mood that has swept the rest of the world.

But don’t rush to lock in your mortgage to a fixed rate just yet.

The surprise 0.25 basis point rate cut by the Reserve Bank of Australia (RBA) pushed the cash rate down to 1.75 per cent. While that’s low by Australian standards, in Europe rates are closer to zero or even negative (where you pay the bank to warehouse your money).

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The banks moved quickly to cut rates in response. Mortgage rates with a ‘three’ in front of them are now available.

The latest research from Canstar shows that while the average standard variable mortgage rate is 4.77 per cent, it is possible to find deals of 3.73 per cent.

0512deflationIf you were to fix your mortgage for three years you could get a deal as cheaply as 3.89 per cent. But there are two reasons why it might not be a good idea to move in that direction.

One is that the professional market is tipping more rate cuts.

More rate cuts likely

Independent economist Stephen Koukoulas told The New Daily the futures market (where traders speculate on future rate movements) “is predicting only a 25 per cent likelihood of a rate cut in June. But for August the likelihood is 85 per cent”.

According to the futures market, the cash rate is expected to be 1.54 per cent in August, he said.

New RBA chief Stephen Lowe may cut further. Photo:AAP
New RBA chief Stephen Lowe may cut further. Photo: AAP

Looking further ahead, Laurie Conheady, fixed income strategist with investment house JB Were, said “the market has priced in a rate cut by October and it is starting to price in another by March”.

That means by next March interest rates could have come off another 0.5 percentage points, with the cash rate sitting on 1.25 per cent.

Were you to lock in a fixed rate mortgage now, you could find yourself sitting on a mortgage rate for a few years above where a standard variable loan might be.

The fixed rate market tends to move slower than the rest of the market. The current minimum benchmark for a three-year fixed loan is 3.89 per cent compared to 3.99 per cent a year earlier.

So if you’re thinking of fixing it might be a good idea to wait.

There could be a sting in fixing rates

David Simon, principal of advisor Integral Private Wealth, said home buyers need to be very careful when moving to a fixed rate loan.

“If you fix a loan and interest rates fall further, the costs of breaking out of the agreement could be massive. It could quite easily be in the tens of thousands.”

Another problem with fixed rate loans is they offer very little opportunity to boost your repayments of principal if you get the opportunity, Mr Simon said.

“With a variable [rate] you can pay in as much as you like.”

The March quarter consumer price index (CPI) came in at negative 0.2 per cent, meaning the economy is officially suffering deflation. Were that to continue, paying down debt would become increasingly attractive as debt would grow in relative terms as prices fell, Mr Simon said.

A sensible way to deal with the low rate environment may be to lock in a part of your mortgage when rates fall further and leave part in a variable to pay down as quickly as possible.

More news on deflationary pressures emerged with analysts from investment bank UBS saying the returns on equity of the big banks is the lowest it has been since the global financial crisis. Ratings group Moody’s said bad debts in the banking sector were rising.

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