Calculating at 8% interest rate

[onion33]

Hi everyone,

I'm using a cash flow calculator in Excel. I just read a book that said to calculate cash flow with 8% interest rates (to see if you can afford the property when rates go higher).

Currently 4.79% = $166 out of pocket per month
Calc at 8% = $968 out of pocket per month!!!

Does this mean I shouldn't buy IP2 as those figures are a bit scary!?
How do you all deal with the 'borrowing while rates are low' situation?

Thank you.

 

[Peter_Tersteeg]

Rates won't simply jump up to 8% from where they are now, it will take some time.

Increasing rates is often a result of increase inflation. This suggests that wages will also be on the increase, which should put some pressure on rents. Obviously rental increases will lag well behind rate increases, but it does eventually happen.

The other risk mitigation strategy against rate increases is also very simple. Switch some loans to fixed rates.

 

[D.T.]

Its individual to everyone. YOU need to be able to sleep at night with your choices, aka SANF - Sleep At Night Factor.

The other way you could look at it is if you think rates will change in X amount of months, then it should be also assumable that rents or wages should also increase within that timeframe. If you're pessimistic on this, perhaps its best for you not to purchase?

Personally, I'd rather get as many buys in now while i can, all of which are positively geared, so maybe they'll go to neutral when rates rise. Or maybe they'll stay positive if rents rise as well.

 

[Peter_Tersteeg]

Personally, I'd rather get as many buys in now while i can, all of which are positively geared, so maybe they'll go to neutral when rates rise. Or maybe they'll stay positive if rents rise as well.

As long as you can sleep at night, my observations suggest that this is actually a fairly good strategy from a financing perspective.

Lenders assess your affordability on many elements, one is based on the current interest rates plus a margin. As a result we find that for many people their portfolio might be positive cash flow, but by the lenders criteria it's heavily negative cash flow.

This also means that when rates are around 8%, the lenders won't give them a cent even though the borrower may feel that they can afford the loan.

Make hay whilst the sun is shining. When lenders will allow you to accumulate, it can be a good idea to do so because tomorrow they may not be as generous.

The risk of course is that if rates to go up to 8% and then continue to go up, you might get into trouble. Again this I haven't observed this in the past. My previous posts indicate rising rates can be mitigated.

Additionally I doubt rates will increase much beyond 8% in the short to medium term. Rates went up to 9% - 10% in 2008 and it became almost impossible to qualify for a loan. Loan amounts are almost double today what they were then. I expect that rates of 8%+ would be devastating to the Australian economy and the RBA would move to correct this very quickly (as they did in late 2008).

 

[onion33]

Good points guys. I'll take the following as a summary for myself:
- Fix some or parts of your loans
- Have a large cash reserve
- Wages and rents will also increase (not as much, but some)
- Look for cash positive or cash neutral properties if it fits your strategy (that way they won't be majorily cash flow negative if rates do jump).
- If all else fails, go full time at work or even more, go contracting!!!

 

[The Y-man]

- Fix some or parts of your loans

One of my friends fixed at the wrong time - like at 8% or something for 3 years because he thought it was going to keep hiking....

On the other hand, we routinely fix for 1 year if prepaying interest etc.

the Y-man

 

[onion33]

Prepaying interest is an interesting point. Maybe I should do that at the end of this financial year, as I'll be on maternity leave the next fin. year.

 

[Redom]

Definitely a good idea to do interest sensitivity tests and it does highlight the crippling effect it would have on portfolios.

Generally its prudent to balance your portfolio to be able to handle an increase in rates.

Personal view - days of interest rates at 8% are over (for the next decade or so). In decades past, 'neutral monetary policy' setting would see interest rates near that level - i think neutral rates are considerably lower now.

We just wont grow fast enough for inflation to begin running away (incomes arent growing fast enough). Rates are at rock bottom now and we're struggling for trend growth. Also we'd have a dollar above parity with rates at that level.

 

[macca446]

Hi everyone,

I'm using a cash flow calculator in Excel. I just read a book that said to calculate cash flow with 8% interest rates (to see if you can afford the property when rates go higher).

Currently 4.79% = $166 out of pocket per month
Calc at 8% = $968 out of pocket per month!!!

Does this mean I shouldn't buy IP2 as those figures are a bit scary!?
How do you all deal with the 'borrowing while rates are low' situation?

Thank you.

By buying in at the right time of the market and achieving a good buy in price is where you make the money,if you are worrying about 8% rates now you need to have rethink your investing, as thinking like this will hold you back and lose potential deals.You need to be decisive in property not a procrastinator .

Macca446

 

[Redom]

You need to be decisive in property not a procrastinator .

Macca446

Great advice Macca446. If your not, you can bet that someone else will be.

 

[Paul@PFI]

Hi everyone,

I'm using a cash flow calculator in Excel. I just read a book that said to calculate cash flow with 8% interest rates (to see if you can afford the property when rates go higher).

Currently 4.79% = $166 out of pocket per month
Calc at 8% = $968 out of pocket per month!!!

Does this mean I shouldn't buy IP2 as those figures are a bit scary!?
How do you all deal with the 'borrowing while rates are low' situation?

Thank you.

8% is a good stress test. Have you thought of using PIA sold by Somersoft ?? Its very good at this modelling etc. Well worth the cost.

I suspect you haven't thought through what rents would do if interest rates were 8%......Wages would inflate. Prices too and so would rent.

 

[Chris B]

Hi everyone,

I'm using a cash flow calculator in Excel. I just read a book that said to calculate cash flow with 8% interest rates (to see if you can afford the property when rates go higher).

Currently 4.79% = $166 out of pocket per month
Calc at 8% = $968 out of pocket per month!!!

Does this mean I shouldn't buy IP2 as those figures are a bit scary!?
How do you all deal with the 'borrowing while rates are low' situation?

Thank you.

One option is to set additional money aside each month (ideally into an offset account) as if the current rate was 1% higher (or whatever you're comfortable with) than the current rate. This will mean that any initial interest rate increases do not impact your monthly budget.

If rates continue to stay low for an extended period, your offset funds will build up and you will have a decent amount of additional money to put towards repayments if rates do increase beyond the repayment buffer you have allowed.

 

[onion33]

I agree. Definitely not a procrastinator. Bought my first IP a month ago and ready for IP2.

I keep all my money in my offset account, which is around $90k. I'd like to put in an extra 1% into the offset as buffer, but I can't tell which money is which! hahaha.

What I mean is, I wish I had multiple offset accounts - one for buffer, one for spending that month. That way I could cleary see what I'm doing!