Owner or renter, boss or wage slave, the coming interest rate hike
Australians are famous for their love their credit and, according to the latest government fig-ures, currently hold a record $28.2 billion debt on their charge and credit cards alone. So it’s no wonder that the mere mention of a rise in interest ratesis about as welcome in many quarters as, say, discoursing on the potential for shark attacks is on Bondi Beach.
Yet all signs point to the Reserve Bank of Australia lifting interest rates sometime this year, and possibly within the next six months, with the economy continuing to grow and the consumer price index edging ever closer to the government’s outer-tolerance limit of three per cent per year. And when the rise comes, it’s not likely to be that temporary a situation, either: economic forecaster BIS Shrapnel’s senior economist, Matthew Hassan, has warned that an increasingly tight job market will push wages up over the next two years, leading to higher prices and, ultimately, interest rates that are “expected to peak at around 8 per cent in late 2006”.
But there’s no need to cue the Jaws theme just yet. Even if the cost of money – which is, in essence, what interest rates represent – is poised to poke skywards like the dorsal fin of a circling great white, there is no need to panic. For when it comes to both hungry sharks and rising rates, experts agree that a lot of panicky shrieking and splashing about will only make things worse.
Homeowners (who represent about seven out of every ten Australians) are obviously going to be the first to feel the pinch, and should make sure their home financing is structured properly: “We suggest that people have one-third of their mortgage on a honeymoon rate, with another third being fixed for five years and the last third being fixed for ten,” advises Christine Davie, a certified financial planner with Melbourne-based Donohue Financial Planning. According to her, this is the best way to hedge one’s bets as interest rates rise and fall over the period of the loan. “The banks have been giving away money as fast as they can for the last several years, and people who are highly-geared should think about this.”
Davie adds that when it comes to interest rates, it’s not smart to go crazy trying to find the lowest rate – “it’s actually very hard to find the bottom of the market,” she says – but that does not mean mortgage holders shouldn’t try and at least do a deal with their individual bank. After all, notes Davie, everything’s negotiable: “It’s often worth asking your bank if that’s the best they can do. But just because the sign in the front window says ‘6 per cent’ doesn’t mean they won’t come down if you ask, or even threaten to take your business elsewhere.”
Meanwhile, for those Australians who don’t own their homes yet, but are looking to join the ranks of first-time homeowners, this is a critical time – one in which careful planning can pay off big.
The first thing to remember is, bide your time. In fact, with interest rates heading north, there is “no rush to get into the housing market right away,” says Damian Cullen, Managing Director of Cullen Financial Planning in Sydney. Instead, put your money someplace smart: “When you’re looking to buy within a twelve to twenty-four month timeframe, really the only place to be is in cash or fixed-interest investments,” cautions Cullen, who adds that when it comes to that crucial down-payment nest egg, “don’t even think of going near the share market”. The second thing to keep in mind (especially for young buyers) is that circumstances change. For example, says Christine Davie, just because a couple consists of two high-earning professionals today does not mean both parties will still be bringing home fat pay packets of five years ago. And the number one reason for this is kids.
“People get married and buy a house and never think about what might happen if they only had one salary coming in, or if one of them decided to take time off to care for a child” she says. Thus couples often wind up either putting off having children, or find themselves in tough circumstances when kids do arrive with a lot of hard choices to make. Davie adds that even if both mum and dad keep working, children are expensive, and childcare can eat up an awful lot of that second income. The old days of buying more home than one could afford may still make economic sense (though it’s an old financial planning chestnut born in the days when one-income families were the norm, not the exception), but it can seriously interfere with one’s work-life balance.
For both owners and renters then, rising interest rates can ultimately mean – either for direct or indirect reasons – less money in the kitty at the end of the week. Smart planning now, says Davie, can avoid a lot of pain later: “If you have personal debt and loans and credit cards, this is the time to consolidate things,” she says. “And maybe, if you find that you keep getting into trouble, you should even think about cutting up the credit cards”.
Meanwhile, companies as well as individuals are poised to feel the effect of an interest rate rise, according to George Etrelezis, Managing Director of Western Australia’s Small Business Development Corporation, and business owners will feel it in a variety of ways.
“First of all, there is the straight bottom-line effect that interest rates have on the cost of borrowing, whether for purchasing equipment or obtaining working capital, and interest rates also factor in to leasing costs and replacement costs,” says Etrelezis, who adds that “there’s certainly an effect that rates have on the dollar coming in the door of a business. And as consumer sentiment dips as they have less money to spend, this means that various industries like the building trades will suffer as people decide to, say, put off building an extension to their home”.But there are other and more pernicious ways in which businesses may feel the pinch as well, and this is where Australian entrepreneurs need to keep a close eye out in coming months. Unless their business is a bank, they need to make sure their customers don’t treat them like one.
“Debtors will quickly start to become an issue for businesses,” says Etrelezis, “and there will be more and more of them who will try and extend their terms of credit. And it makes sense: with the cost of money going up from the banks, they will try and get cash somewhere else,” even if it means stepping on your goodwill.
As a result, the mantra that (especially for small businesses) “cash flow is king” becomes ever more important. Etrelezis says all business owners must start to think like the big boys, who are very strict about their payment terms and are not afraid to enforce them. “Be disciplined, and if someone goes too far beyond their 30 days, don’t be afraid to turn away their business. Remember: you can’t afford to let a regular customer slide for 60 or 90 or 120 days, and if they go down they will take that cash flow down with them”.
Finally, as tempting as it is to focus solely on interest rates at home, smart planning means keeping an eye on what’s happening beyond Australia’s shores as well. According to Geoff O’Neill, Managing Director and CEO of Advantage One, a financial planning and investment counseling firm which caters to high net worth clients in Adelaide, interest rates in the United States are about to make a move as well – something to bear in mind when making investment decisions.
“If you look at the U.S., their rates are at a historic low, while their economy is moving into a period with improved economic fundamentals. And as their economy expands, we’ll start to see American interest rates edge up to keep a lid on growth”, says O’Neill, who adds that this will probably knock some value off the Australian dollar. “Our dollar looks strong right now, but that’s really a reflection of the weakness of the U.S. Dollar,” he points out. “As we see an improving economy in the States leading to an increase in rates, then we can also see the Australian Dollar falling back closer to the .70 mark,” something that will affect our balance of trade and the performance of exporting versus importing companies.
While those two sectors will likely balance themselves out on the equity markets, O’Neill cautions that when it comes to the share market in general, it’s time for investors to get realistic and says that “this current rate of growth is not sustainable, and we must get more focused on achieving the real rate of return out of equity markets, which should be something like 10 percent or less – and certainly not 18 to 25 per cent.”
It can be easy in Australia to get used to living in a place where low interest rates and virtually full employment rule the day, and where the economy regularly weathers storms that lay low the finances of other countries. But while a rise in interest rates might be unpleasant – especially for the unprepared – it’s also the sort of medicine that can keep other more unpleasant numbers (like inflation and unemployment) down as well.