Interest rate movements – How do they affect you as a borrower?

Posted Tuesday, April 14, 2015 Comments (0)

The Reserve Bank of Australia (RBA) met last Tuesday (7th April) and held the official cash rate at 2.25% for the second consecutive month since the 25 basis point reduction in February. Prior to the meeting, the market consensus was swayed towards another rate cut and, given the outcome that has transpired, there is a distinct possibility of another cut in the coming months. 

The one thing you can be certain of on the first Tuesday of each month is the number of economic ‘experts’ that come out of the woodwork with various predictions – myself included. The vast majority of Australians pay a lot of attention to what the RBA says and does. The reason for this is quite simple – the RBA decision on the cash rate affects us all, in particular home owners, commercial property investors and small business. 

How do rates affect borrowers? 

Interest rates directly affect the cost of borrowing money and therefore the cost of doing business. For property investors and small business owners, changes in the official interest rate can significantly affect cash flow. The more debt a borrower has, the greater the impact a change in interest rate has on them. 

With all other things being equal: 

When rates go up… 

  • The cost of borrowing money increases 
  • Variable rate interest payments increase 
  • Cash flow is reduced 

When rates go down… 

  • The cost of borrowing money decreases 
  • Variable rate interest payments decrease 
  • Cash flow increases 

Are fixed rates helpful? 

The option of fixing interest rates for a certain period of the loan term can assist in the following manner: 

  • By hedging to protect the borrower/business from the direct impact of an increase in interest rates 
  • By providing a known funding cost to the borrower/business to allow for a more stable cash flow 

However, by fixing interest rates borrowers are open to the following: 

  • Not receiving the direct financial benefits should interest rates fall during the term of the fixed component 
  • The incurrence of higher financial costs following alteration to the contracted terms of the loan such as early loan repayment in full or in part. 

Borrowers also have the option to fix a certain portion of their loan amount with the remaining portion held on a variable rate. For more information on fixed interest rates see our previous blog article. 

Planning ahead 

Confused by all the economic data and expert opinions on future interest rate forecasts? Like most things, you will be in a better position to cushion yourself and your business from rate movements by keeping it simple and planning ahead. If your payments are subject to movements in interest rates, plan ahead by preparing cash flow forecasts based on current rates as well as forecasts which take into account both rate cuts and increases by 0.25-0.50% respectively. 

By being aware of the monetary impact of rate changes on your repayments in advance you should be able to adequately prepare and plan for future interest rate changes. This can be achieved by preparing for a rise by creating a buffer now to absorb extra costs in the future or by looking at ways to be ready to take advantage of a fall in rates by reducing core debt and/or negotiating a cheaper rate.

Reegan Piper is a Business Development Manager at Balmain Brisbane, specialising in sourcing commercial investment, construction and residential loans up to $3 million for property investors, developers and owners in South East Queensland. 

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