Business News

How scared should we be of a rate rise?

| More

by Peter Switzer

With everybody tipping an interest rate rise before the Melbourne Cup today, there’s one question that should be asked by everyone in debt. And that question is: “Just how scared should we be?”

Right now, the maniacs who were predicting a 0.5 per cent increase on Cup Day have pretty well disappeared, but there are still a few around.

These ‘experts’ are, inexplicably, terrified of inflation, despite the fact that the current Reserve Bank Governor has a near fanatical crusade to beat this curse upon an economy.

Hold back on the rate rises

That’s why I think we will see a 0.25 per cent rate rise before the Cup, though I do not think we have to have one today.

In my perfect world, I would delay rate rises until February but keep the warnings going that rates will rise in 2010. This would give retailers a chance of having a solid Christmas, which is needed given that this period is the most important for so many retail businesses.

Anyway, that’s my perfect world. Back in the real world, rates are to rise, so how scared should it make you?

Your home loan

The CBA’s standard variable rate is 5.99 per cent, which is really 6.12 per cent when you add in fees and charges. This is called the comparison rate of interest and this is what you should always ask for when going into a home loan so you know the real costs.

Let's look at the cash rate, now at 3.25 per cent, and the home loan rate, which is say six per cent for convenient comparison purposes.

The expert RBA watchers say the Big Bank wants to take the cash rate to five per cent over 2010 and into early 2011. If that were the case, we would have to add about 2.75 per cent to the six per cent variable rate we have now. This would take the typical home loan rate of interest to 8.75 per cent! That’s pretty steep and I think it’s way too high but that’s what history plus the gap between the cash rate and the variable rate is suggesting.

Along the way over the next year and a half, there could be some downgrades in enthusiasm for rate rises by the Reserve Bank. This will be determined by prevailing inflation rates and just how strong the economy is.

Right now, the Reserve Bank is really very positive on the economic outlook but the Treasury is less so, judging from the recent mid-year economic forecasts.

Rate rise impact

By the way, over the year or so securitisation will hopefully emerge again, albeit more safely, and that will give the home loan market more competition. Possibly a new age Aussie John Symond will take on the banks and interest rates will rise more slowly as competition becomes more intense.

For those wanting to calculate what the impact of an interest rate rise could be in simple terms, it’s a $20 rise per $100,000 loan per 0.25 per cent rise. (It can be a bit less, but this makes for easy calculation.)

So, if you have a $500,000 loan, then you will have to find an extra $100 a month for your home loan. If rates go up another two per cent then the cost would be $800 a month or eight 0.25 per cent slugs.

Work this out and make sure you are ready for this over the next few years.

I go for two per cent because I can’t see home loan rates at eight per cent or greater for about three years or more.

The recovery

I reckon the recovery will be good but not great. I also think local inflation will be helped by the strong dollar and the fact that our government debt will be less than expected.

Everyone should be wary of rate rises, but I would not be as scared as you could be if you listened to all of the economists currently feeding the scaremongers who create some of the headlines in newspapers, on radio news bulletins and on television current affairs programs.

We have enjoyed emergency level interest rates and we’re heading back to normal rates but normal Australia will take some time to reappear. You don’t overcome the worst global economic collapse since the Great Depression without a few economic hiccups along the way.

Those hiccups should slow down the rise in interest rates. If you are not prepared to take my word on this as an economist, then take it as a journalist!

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

The Switzer Super Report is a newsletter and website for self managed super funds. With exclusive commentary from Peter Switzer and Paul Rickard the Switzer Super Report will help you maximise your after tax investment returns and grow your DIY Super. Click here for a free trial or subscribe today.

Published on: Tuesday, November 03, 2009