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In This Video:

00:32 How to deal with interest rates?
02:55 How to predict interest rates?
03:56 How to protect yourself from rising interest rates?

Good day everyone Daimien here. Today we are going to talk about interest rates, one of the greatest fears that a lot of property investors have.

So what could go wrong with interest rates? The big problem with interest rates is that they could take off and go through the roof. If you are holding a large portfolio and you are on a variable rate then that could very quickly turn a positively geared property into a negative one creating a big problem for you.

How to deal with interest rates?

So how do we deal with that? The first thing you have to understand is that the banking system in Australia has changed. You might have heard the horror stories about the late 80’s and the early 90’s, where interest rates hit ridiculous levels like 18-19%. After that, something very significant occurred and have reduced interest rates dramatically, and that was the Reserve Bank having an independent board to direct on what to do with interest rates. That independent board controls the setting of the rate and tells the reserve bank what the rate should be. They brief to do that to keep the inflation between 2-3%.

So, if inflation is taking off and the economy is too strong and getting out of control, they’ll put the interest rate up. As the reserve bank is the body that provides money to the normal banks, who lend money to you, the reserve bank will put interest rates up, then the normal banks will put the interest rates up on you, and you will then have less money in your bank account, you will spend less money and that will destimulate the economy. Conversely, if the economy stalling, they’ll drop the interest rate, the bank also will drop their interest rate, you will have more money, you’ll spend it and that will stimulate the economy. Ever since that system made in place, we’ve seen interest rates plum it, and then the base rate staying at around the 5% mark.

Right now, the interest rates are ridiculously low and it is a wonderful time to have an investment portfolio because you can borrow money so cheaply. But what happens when the interest rates go up? Well the first question we need to ask ourselves, are they going to go up in any major way and how can we tell? We can tell what the interest rates are going to do by looking at the fixed rate and in particular, the 3 and 5 years fix rates. If you are on a fixed rate and the reserve bank starts putting the interest rates up, can your bank put interest rates up on you? The answer is NO! Because that is the whole purpose of the fixed rate. So the banks want you on the variable rates, so they won’t carry any risks. If you are going to insist being on a fixed rate, then they have to cover their back sides by making sure that the fixed rate is at the level that they can handle.

How to predict interest rates?

Now the banks employ hundreds of economists to study the economy and try to predict what is going to happen with the economy. In return, what does the reserve bank is going to do with them with the base rate? If you want to know what are those economists are thinking, all you have to do is see the difference between the fixed rate and the variable. If the fixed rate is much higher than the variable, then that tells us that the banks think that the interest rate is going up, because they want to keep a buffer between where you are on the fix and where the variable is. So as the variable comes up, they can still make a profit. Conversely, if the fixed rate is about the same as the variable they should tell you that the rate is going to stay the same for a long period of time. In a very rare occasion, fix rate is indeed lower than the variable they should tell you that the rate is going to come down. Now all you need to do if you are worried about interest rate going up is look up at the 5- year fix compared to the variable that should give you some comfort as to what may occur.

How to protect yourself from rising interest rates?

You’ve got the option on how to protect yourself from interest rates from going up and there are two things that you can do:

1. You should make sure that you have a portfolio that is positive cash flow to start with. If it is already negative and the interest rate starts going up, then that pain is only going to get worse. If it’s positive and you’ve got some room to move, if the cost starts going up through paying more on interest rates, of course, you can always fix your rate if you want to but the fixed rate will cost you more than the variable rate overtime that extra amount of money. If you think about as an insurance policy premium, i.e. if there is an insurance policy you can pay to make sure that you and your interest rate didn’t go up, would you pay it? And in that case, you would probably say “Yes!” therefore, it is fine to be on the fixed rate if you are seeing it in that frame of mind.

2. You really want to make sure that you always maintain a large cash buffer. I say to people at least 3 months mortgage repayments per property seating in a cash buffer usually an offset account. If you are living in your own home that offset account should be against the original mortgage on your loan because that particular loan is not tax deductible. Now if you’ve got that sort of cash lying around, when interest rates start taking off, that cash can act as a buffer and start absorbing that extra money you have to pay until such time you make any formed decision regarding your portfolio. Maybe you’ll decide to sell, maybe refinance but you won’t get caught out.

Remember cash is king. You want to have plenty in the bank.

Interest rates? Will they take off again like in the eighties and the nineties? NO! Not unless they’ll take away the independence of the reserve bank. What do we do to predict interest rates? Look at the difference between the fixed and variable rates. What can we do to protect ourselves from them in rising? Consider fixing you rates and always maintain a large cash buffer.

That’s it for me today. I hope you’ve got something out of that. If you do please share, please comment, please like, and until next time I’ll say goodbye.

Cheers

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