How high would interest rates have to go to cause you severe hardship?

[keithj]

Mark Bouris of Wizard Home Loans is quoted in todays Sun Herald
The equivalent of the 17% interest rate of the late 1980’s is about 8% today Given that rates are at around 7% and there are expectations of a rise later this year

How high would interest rates have to go to cause you severe hardship?

Assume rents go up by less than 5%, and the interest rate rises occur over an 18 month period.

What strategies do you have in place to mitigate that risk?
What would you do if rates got to your hardship level?
How long could you survive for if this happened?

[Aceyducey]

Keith,

You've made this a rather bearish survey.

I did a similar one some time ago with much bigger prospective interest rate increases.

Most people were fine up to at least the 12% interest rate level.

Cheers,

Aceyducey

[Spiderman]

1. What strategies do you have in place to mitigate that risk?
2. What would you do if rates got to your hardship level?
3. How long could you survive for if this happened?

1. Risk Mitigation Strategies

a. Research of areas purchased in
b. Purchase of IPs that are likely to be attractive to tenants
c. Avoidance of heavy negative gearing (ie gross yields 8-10%)
d. A maximum LVR limit across the portfolio (though currently I'm somewhat over my self-imposed 50%!)
e. Maintenance of significant liquid assets in non-property asset classes
f. Generous monthly savings program (in non-IP areas)
g. Where these can be afforded, extra payments to loans to reduce loan term and thus interest paid

2. What to do if rates rose

a. Reduce monthly savings program to fund increased interest bills
b. If the rise is large and sustained, and cashflow was suffering, consider selling non-IP investments to reduce debt on IP #1.
c. Depending on valuations recieved for other IPs, redraw monies from these and/or restructure loans to fully pay off first IP.

3. How long could you survive

Indefinitely! That's unless rates were to rise to 12-15% or more and stay there, when some difficulties might be experienced. If rate rises were less than this the main problems could be a reduction of portfolio diversification, risk of capital losses (if forced to sell shares, etc) and reduced base for capital growth in the non-IP portfolio. If rate rises were associated with rising inflation, then it woudn't be so bad, provided wages rose as well and living expenses remained at the present proportion of wages.

Regards, Peter

[superted]

1. Risk Mitigation Strategies

a. Research of areas purchased in
b. Purchase of IPs that are likely to be attractive to tenants
c. Avoidance of heavy negative gearing (ie gross yields 8-10%)
d. A maximum LVR limit across the portfolio (though currently I'm somewhat over my self-imposed 50%!)
e. Maintenance of significant liquid assets in non-property asset classes
f. Generous monthly savings program (in non-IP areas)
g. Where these can be afforded, extra payments to loans to reduce loan term and thus interest paid

2. What to do if rates rose

a. Reduce monthly savings program to fund increased interest bills
b. If the rise is large and sustained, and cashflow was suffering, consider selling non-IP investments to reduce debt on IP #1.
c. Depending on valuations recieved for other IPs, redraw monies from these and/or restructure loans to fully pay off first IP.

3. How long could you survive

Indefinitely! That's unless rates were to rise to 12-15% or more and stay there, when some difficulties might be experienced. If rate rises were less than this the main problems could be a reduction of portfolio diversification, risk of capital losses (if forced to sell shares, etc) and reduced base for capital growth in the non-IP portfolio. If rate rises were associated with rising inflation, then it woudn't be so bad, provided wages rose as well and living expenses remained at the present proportion of wages.

Regards, Peter

The problem is the vast MAJORITY of people with mortgages/"property investors" could not tolerate another 1 -2 % in rate rises. A lot of forum people (as shown by Aceys old poll) are substantially more educated and could possibley handle >10% with the plans they have in place.

[Rolf Latham]

Hi Ted

Me thinkest you are right.

What we generally dont look at is the % increase in real cost of money.

The last 2 rate rises increased the cost of money by near 8 .

Another 1 % on top would be another 19 % on the previous rise.

OUCH, thats why many of my FHOG buyers on tight budgets choose fixed rates, yes they are more costly but they will shield against rises at least for a little while

ta

rolf

[Aceyducey]

The problem is the vast MAJORITY of people with mortgages/"property investors" could not tolerate another 1 -2 % in rate rises. A lot of forum people (as shown by Aceys old poll) are substantially more educated and could possibley handle >10% with the plans they have in place.Could be right there Ted...but those people are not going to be in the majority responding to Keith's poll on the forum :)

Most of them have very limited financial education.

That said, banks generally ot my knowledge check serviceability against whether people can pay with rates 2% higher....thus theoretically anyone getting a loan today the banks consider a good risk at 2% higher rates (aka 9% mark).

Cheers,

Aceyducey

[geoffw]

What strategies do you have in place to mitigate that risk?Risk mitigation for me is fixed interest loans. I've had a loan which was higher than average- but that helped in the SANF.

There is now a product which gives me a fixed interest loan- but which allows me to change almost all to a variable, without penalty, if I choose.

[Peter 14.7]

Hi All

This is great thread!!!! WHY because it shows a fundamental flaw in Somersoft.... which is the level of expertise here compared to the general populise.

Forumites are abnormal when compared with the majority of investors. I dont know the recent figures but the average IP investors has one only on a set and forget system. I know a number in this camp who frankly don’t even understand NG and CGT but bought an IP because everyone else was doing it.

So let’s review the comments on rates...

Acey points out his thread found 12% rates would hurt for SS but Mark of Wizard Home Loans comment that 1% more was equal to 18% in 1980 context!! That a BIG CALL.

IF he is right, and IF the general thought (in the article of SMH yesterday) that we will see another 0.5% in the next 18 months then we should all be holding off and waiting for the fire sales to hit the market in 12 months or so?

Hi Rolf ,

So sorry I missed you talk BTW, you post and insider knowledge is invaluable here. You seem to agree that is very tightly balanced and hence you advise (very wisely) to fix rates.

Hi Super Ted

You summarize my thoughts in your comment

The problem is the vast MAJORITY of people with mortgages/"property investors" could not tolerate another 1 -2 % in rate rises. A lot of forum people (as shown by Aceys old poll) are substantially more educated and could possibly handle >10% with the plans they have in place.

So again know is good time to hold back and to watch the sky. It would appear lending is not slowing as the RBA had hoped and another 0.25% to come this year.

And lastly the great wildcard as highlighted in this article.....

OIL prices. This morning the little Alfa filled up from empty on premiun at $1.14c in the City. Over $65 to fill a tank. :eek:

Ouch...Peter 147

[Les]

G'day Acey,

Long time, no see !! You made a very interesting comment :-
thus theoretically anyone getting a loan today the banks consider a good risk at 2% higher rates (aka 9% mark).
And therein lies a tale!!! If 8% is going to hurt so much today (a la Mark Bouris comment), yet Banks are checking that people can handle 9%, it would be really interesting to know just how many people are PASSING the Bank's limit!!! Significantly lower than previous is my guess....

Maybe the Banks themselves are forcing prices lower by dis-allowing loans in this way - hmmmm - interesting. This is likely why "all booms must end".... it's the Banks that do it!!!

Good comment, mate (and, G'day Jas :D)

Regards,

[XBenX]

I think the debate is being taken a bit off track by an assumption.

Im pretty sure MB would be referring to the RBA rate, therefore 8% would mean a 2.75% rise.

I read the article, whilst I havent looked into the figures I didnt have any problems with the statement - Ive posted enough bs about how MP and its effects on the economy has changed.

[Les]

G'day Xbenx,

You said this:-
Im pretty sure MB would be referring to the RBA rate, therefore 8% would mean a 2.75% rise.
I think you meant a 1.75% increase didn't you? i.e. at the moment, Bank rates are 5.25%, mortgages are ~ 7% ( a 1.75% lift)

So, if what you say is right, then Mark Bouris meant "when Interest rates hit 9.75%" the proverbial will hit the other proverbial..... ahh, yeah - that's 2.75% ABOVE where we are now !!!! That's what you meant, eh?


And that is a 39% lift above current rates (9.75 divided by 7) - so, that's a HUGE impost, especially when wrestling with a huge mortgage.... That would certainly tip some scales....

Regards,

[keithj]

Im pretty sure MB would be referring to the RBA rate, therefore 8% would mean a 2.75% rise.

I read the article, whilst I havent looked into the figures I didnt have any problems with the statement - Ive posted enough bs about how MP and its effects on the economy has changed. To quote a bit more of the article on p6 of Investor sectionBecause of today's much larger mortgages, Mark Bouris of home lender Wizard said the equivalent of the late 1980's 17 per cent interest rates is about 8 per cent. That's only 1 per cent away, or four lots of 0.25 per cent.The retail lending rate was 17% in the 80's, so I wouldn't expect him to equate a 17% retail rate with an 8% RBA rate.

[Aceyducey]

The equivalent of 17% is 17%.

Cheers,

Aceyducey

[XBenX]

To quote a bit more of the article on p6 of Investor sectionThe retail lending rate was 17% in the 80's, so I wouldn't expect him to equate a 17% retail rate with an 8% RBA rate.

Nope the RBA Cash Rate was 17% (and sometimes more) in the late 80's.

It would be all on the RBA website if you want details.

[Peter 14.7]

Regarding the confusion re RBA versus home loan rates relating to Mark Bouris comments in Saturday’s SH Investor Cover Story I have the article and FYI here is his comment verbatim:

Because of today's much larger mortgages Mark Bouris of home Lender Wizard said the equivalent of the late 1980's 17 per cent rates is about 8 per cent

The writer David Potts then writes:

That's only 1 percent away or four lots of 0.25 per cent hikes.

Typical rates being around 7% on average.

The most economists expect this year is another 0.25 per cent. And that would have more to do with global rates rising than anything nasty happening here.

The article raise lot of good points and wisely does not state a conclusion other than

if your already stretched then now is good time to sell as if the experts are right then the market isn’t going to get any better for a long while.

If Bouris is right I still subscribe the general investor will be stretched if rates rise allowing more financial investors to get some bargains.

Personally that my call as well. We will see another 0.25% this year I think and next year is the real test.

Regards Peter 147

[Peter 14.7]

HI All

I know the poll is not closed yet but very impressive to see of those who voted almost 89% (a massive margin) can survive 3% or greater rates!

If rates do rise then I expect to bidding against Acey, XbenX, Les, Sim and the rest of the crew on a regular basis at the fire sales.

See you there, Peter 147

[Thommo]

The quoted numbers don't matter much.

The US has just raised it's headline rate to 1.25% but Johnny Six Pack has never paid much less than we do on our mortgages. Their big advantage is that they can lock the rate in for 25yrs.

They talk about a borderless world but I can not take out a USD denominated mortgage on EMOH ROU and yet I'm convinced that it is the best thing I could possibly do.

Before the "bad" days of 18% rates in the '80s I took out an LOC fixed @ 90day bank rates + a couple of % retail margin. On this basis my LOC never went over 14%. That was with Standard Chartered who found life hard along with Citibank at the time so they sold out to a local HP company, maybe Custom Credit who then ignored the the contract so we parted ways.

If you were to take out a floating rate LOC then it would clearly pay to establish the bench-mark for the rate. It worked for me!

T

[willair]

Thommo,
imho,People who use borrowed funds,should always do so with their eyes wide
open,and in full realisation of the likely consequences if things go wrong,we started in real estate in those 18% days, and i know in simple terms time repairs everything..
Good luck
willair..

[Thommo]

Thommo,
imho,People who use borrowed funds,should always do so with their eyes wide
open,and in full realisation of the likely consequences if things go wrong,we started in real estate in those 18% days, and i know in simple terms time repairs everything..
Good luck
willair..I've signed a lot of contracts over the last 40yrs and I have become far more wary than many on this forum seem to be.

T

[keithj]

Comment from Robert Gottliebsen in todays Australian (http://www.theaustralian.news.com.au/common/story_page/0,5744,10072450%255E16946,00.html)

Australian consumers are highly leveraged, so they would be very sensitive to higher interest rates. A quarter per cent interest rate rise would have an immediate effect and a half a per cent rise would see those arrears jump rapidly.

Macfarlane does not have to lift rates because of the housing market. Looks like us forumites are in a different class - better not tell the RBA.

[willair]

Thommo,
That may well be the case,you only have to ask yourself the simple question,
if you have seen this all before,as i have several times in my life,i dont care 1%
what true value indications are on paper.The outsider has no indication of the real genuine face value of any property till they have the knowledge of what the vendor is willing to accept,i have people up your way that tell me the same story,how many For Sale signs can you put in one street..enjoy the rest of your day....
Good luck,
willair...

[Aceyducey]

I've signed a lot of contracts over the last 40yrs and I have become far more wary than many on this forum seem to be.Thommo,

I don't get your last bit.....

Of my friends it seems it's the 20-30-something kids who generally have to advise their parents on the details of contracts.

These days young people sign so many more contracts then their parents did when they were young that we're all becoming more astute at looking at the fine print.

Of course, the contract writers are getting better at it too :)

Cheers,

Aceyducey

[Thommo]

Thommo,

I don't get your last bit.....

Of my friends it seems it's the 20-30-something kids who generally have to advise their parents on the details of contracts.

These days young people sign so many more contracts then their parents did when they were young that we're all becoming more astute at looking at the fine print.

Of course, the contract writers are getting better at it too :)

Cheers,

Aceyducey
I must have been precocious :) I used to advise my Mum 'n' Dad.

There must be two distinct sets of GenXers. Most I meet don't even understand a phone contract and can't be trusted with a c/card.

Thommo

[Aceyducey]

There must be two distinct sets of GenXers. Most I meet don't even understand a phone contract and can't be trusted with a c/card.

No-one understands phone contracts ;)

Yup there are certainly people out there with no idea. They keep the engine going so the rest of us can drive the car.

Cheers,

Aceyducey

[Peter 14.7]

Want to see an example of the an average investor? Read on.

This morning I advised a Board of Solicitors on a commercial property purchase. Afterwards over coffee one of the solicitors asked my residential IP thoughts stating "I should start investing" but added he had no experience as he had only ever bought a PPOR. After the coffee he excused himself as he had to attend the Supreme Court at 10am and argue a case.

Now I dont know what 40 year old + Supreme Court Lawyers earn but it must be $200k or more p.a. Yet for all this income, not one IP and no idea where to start?

So if this is an average investor (lots of money, paying lots of tax) is it little wonder sales have not dropped as much and yields are 3% when they are happy to NG anything regardless of CG.

Just for your info. I personally was a bit stunned. Peter 147.

[Thommo]

We shouldn't be looking at interest rates in isolation. They will not rise much without accompanying inflation.

I believe rising inflation is inevitable so I suppose rising interest rates are too. This article by the Aden Sisters is typical of so much I read now.
http://www.321gold.com/editorials/aden/aden071504.html

Do not despair though, because periods of high inflation are great times to borrow on property. It was in the '70s. May be again in the noughties.

Thommo

[Spiderman]

We shouldn't be looking at interest rates in isolation. They will not rise much without accompanying inflation.

I believe rising inflation is inevitable so I suppose rising interest rates are too. This article by the Aden Sisters is typical of so much I read now.
http://www.321gold.com/editorials/aden/aden071504.html

Do not despair though, because periods of high inflation are great times to borrow on property. It was in the '70s. May be again in the noughties.

Thommo

The 70s produced some strange figures - high inflation AND rising unemployment. Add a stockmarket that went nowhere for years, and
negative interest rates for a while, and the scene is set for a huge borrowing binge and property boom, which happened c 1980.

I suppose the only thing holding things back was regulated banking; the cozy banking cartel would have been rubbing their hands with glee over take-up of the new-fangled Bankcard.

Inflation would have caused spiralling repair & management costs, possibly offset by rising rents, depending on vacancy. However with high interest rates positive cashflow would have been as hard to find then as now, but tax deductions would have been relatively bigger (due to higher interest component on loans).

We can't do much to affect any of this macroeconomic stuff, so we've just got to make the best of whatever comes.

Regards, Peter

[Bill.L]

Hi all,

Hey Thommo, Don't those Aden sisters have such a wonderfull track record. After all it was them who predicted that gold would go to $4000US per ounce back in the early 80's. I can remember reading their newsletter and following their advice :eek: at the time.

I suppose if we get enough inflation in the future they will eventually be right. They can then claim that it was just their timing that was a little out :rolleyes: .

bye

[Thommo]

Hi all,

Hey Thommo, Don't those Aden sisters have such a wonderfull track record. After all it was them who predicted that gold would go to $4000US per ounce back in the early 80's. I can remember reading their newsletter and following their advice :eek: at the time.

I suppose if we get enough inflation in the future they will eventually be right. They can then claim that it was just their timing that was a little out :rolleyes: .

bye
Wouldn't it be too easy if today's paper told us what would happen and not just what did happen? In the US though, inflation is a fact and they have big problems. The debate now is how they "fix" these problems and how that will effect us.

I wont post it here but Richard Russell's latest paints a very bleak picture. Of course RR is wrong pretty often too. If you've read the Aden sisters you will know Richard.

Thommo