Planning for rate rises

Hi all,

I am wondering what peoples' thoughts are on the following. We are currently getting financial and planning for IP# 4/5, in doing so we are doing projections for rate rises up to 8% to see how our cash flow will be affected under different scenarios. Currently with 3 IPs we are cash flow positive by around 10k pa and with our next purchases, in line with our strategy, this may come down to about 7k.

However, when we factor in rates of 8% this becomes 18k neg! Our situation is ok as we have a reasonable amount in our offset, good wages and will look to sell an under performing property to reduce debt.

I have read lots of stories on here in the last 12 months (the golden age of rates!!!) and see lots of people who are currently sitting at neutral or slightly negative.

I would like to hear how experienced investors have considered rate rises in their overall strategy and also how/if newbies have done this? As some food for thought, a rate rise of 3% on a 500k debt will result in 15k extra in repayments, or about 300pw (obviously less after tax). This may be easy for some but I bet some may not be able to maintain their same standard of living when this occurs.

Looking forward to your responses.
 
It's only prudent planning to factor rate rises into your affordability plan. Rates are at an all time low, they will go up again at some point in the future.

What I'm not so concerned about however is if the property is going to be positive or negative cash-flow. It's nice to have positive cash-flow, but often unrealistic in the Australian market. There's also several things that start to happen when rates go up to offset the increasing costs.

Rates increase when the economy is doing well. As a consequence of a strong economy, wages tend to increase. With wage increases comes additional affordability. People can afford to pay more rent. They can afford to pay more for property driving up prices and driving up your own affordability.

Interest rate increases will be offset by rental increases and capital gains. It's often an opportunity to make money, but keep in mind that these increases aren't immediate, they take time to filter through to the property market. When rates come down again, rents generally don't drop, so you're ahead overall.

You can also mitigate rate increases by fixing. You probably won't pick the bottom of the rate cycle, but fixing allows you to lock in your cash-flow. Just be careful and try not to fix at the top of the rate cycle.

Essentially higher interest rates are kind of a good thing, not a bad thing. It's nice to have low interest rates right now, but it can also be argued that the economy is currently worse off than it was during the GFC. I don't think we'll see 10% interest rates anytime soon, probably not even 8%. In 2008 when rates reached 9% it became unaffordable to even qualify for a loan. When rates are too high the economy starts to slow down too much and the RBA tries to compensate by dropping them.
 
This is also a concern for me.

Fixing doesn't seem like a good idea as historically you're better off going variable something like 80% of the time. Besides, the banks have an army of people (read: nerds) forecasting rates so are likely to be better informed than you. Thus if you ever fix rates with them,you're effectively betting against the house - and the house always...erm...usually wins.

Note: given interest on IPs is tax deductible however, that eases some of the pain.

In addition to increasing rent and Peter's points above, if you also diversify by holding some shares it is likely those dividends will increase thus helping affordability.

Combining the above with an ITWV will also help with day to day cash flow issues that might arise.

That said, a 2% rise on a multi million dollar portfolio may still be very painful to absorb. Perhaps you can send your kids to the coal mines to earn their keep (I hope DOCS doesn't monitor somersoft)!
 
Budgeting at 8% is very prudent. However, as Pete alluded to - if rates are increasing to those levels then something good must be happening in the economy :)

Cheers

Jamie
 
This is also a concern for me.

Fixing doesn't seem like a good idea as historically you're better off going variable something like 80% of the time. Besides, the banks have an army of people (read: nerds) forecasting rates so are likely to be better informed than you. Thus if you ever fix rates with them,you're effectively betting against the house - and the house always...erm...usually wins.

Peter raised very good points. If rate rises are concerning you why don't you fix it 3 year for <5% and 5 yr for <5.3%. No need to lose sleep about rates going up by 2% or 3%.

No one can predict interest rate direction or % change all the time. May be historically the banks win most of the time financially with fixed rate but you get peace of mind. If you think the house wins usually, they are betting that the rate won't go above 5.3 over 5 years. What do you think will be the right move for you?
 
You're right Tyla. I had partially fixed rates (and partially variable) back when they were ~8-9% last time round and I found it a good approach. I may do something similar should I see rates going north again in future.

I'm not losing any sleep on it :).
 
Thanks Peter, that is very interesting. It makes perfect sense but I had not thought about it that way. I have a property that was a former PPOR and have had it tenanted for near 5 years now (during this time rates have gone from 7% to 9% and now to < 5%. In this time my rent has only gone from $350 to $360 (refer to intial post - underperforming property!) So I still believe some people will have to rethink their lifestyle should rates get to 8%.

Can anyone enlighten me on this - When banks set their 2, 3 and 5 yr fixed loan rates, do they set these at levels they are expecting rates to be at come the end of that fixed term? I expect they put them just above their own predictions??
 
When banks set the pricing for their fixed rates, they're not really making any predictions on what rates will be after that.

Pricing for fixed rates is primarily decided by what the banks themselves can buy the money for, then then add their own margins to that cost and the result is the rate you pay. You'll never 'beat the banks' by fixing. They win every time because the day you sign the contract they've locked in their profit for the fixed period.

The banks mostly buy the money on the open markets, it's often linked with various bond rates. As a result the fixed rates are a bit of an indicator of where the market expects rates to go, but they're not a prediction by the banks.

If you've got everything fixed for say 3 years, then it may be a shock to the budget when the 3 year fixed rate expires even though your income may have increased in that period. A simple strategy to deal with this is to perhaps stagger your money across several fixed periods. Fix some for 2 years, some for 3 and perhaps some for 4-5 years. This way they don't all expire at once and you can adjust your budget over time instead of all in one day.
 
Thanks again Peter. So, basically, a) the banks fix rates based on the 'cost' of money available to them, and b) the 'cost' of money available to them is one possible indicator of where the 'market' believes rates will go.

When you say the 'market', what are you referring too?

Thanks,
 
Thanks again Peter. So, basically, a) the banks fix rates based on the 'cost' of money available to them, and b) the 'cost' of money available to them is one possible indicator of where the 'market' believes rates will go.

When you say the 'market', what are you referring too?

Thanks,

The 'market' refers to the wholesale marketplace where bonds, debts, etc are traded and determinations on the prices of these financial instruments are made. If there is more demand than supply of a particular instrument at its current price, the price will go up and vice versa.

Similar to the use of the terms 'property market' or 'sharemarket', it can be used in different ways, depending on the context.

For the past year or two, some banks have often been offering fixed rates (1,2 or 3 years) below the variable rates on offer at the time. Often this is done as a special offer to attract new business but in general it suggests the bond market is not expecting interest rates to rise much in the next couple of years.

As a side note, one of the Big 4 have just announced a 5 year fixed rate of 4.99%, which will be very attractive for many borrowers.
 
Back
Top