It’s easy to invest in properties, the most challenging part of investing in properties is acquiring the money for investment. Land and property are typically the priciest assets one can obtain. It is no surprise that those who wish to buy property but partially lack the funds to do so, would go to banks to acquire a loan.
Procuring a loan also gives responsibility to the borrower to pay back the money owed with added interest. This is a good deal which gives the borrower the capability to buy or invest on a property at a certain time. Interest rates are based on different cases and depending on what type of interest rate was chosen for the loan.
The Reserve Bank of Australia (RBA) determines the cash rate which directly influences the interest rates in the economy. The official cash rate functions as a point of reference for loan interest rates of financial institutions. However, the loan interest rates can be modified depending on various indicators assessed by financial institutions. These indicators may include the financial market forecast, development of competition, and loan risks.
How do changes in interest rates affect a property investor?
The rise and fall of interest rates affect the repayments on debt, loans, and mortgages. When interest rates increase, the more costly it is to repay what is owed for a specific amount of time. Inflexible rates can restrict the allotment of finances and limit the number of investment properties which can be handled simultaneously. However, reduced interest rates provides more workability with ongoing mortgages and possibly new investments.
As an investor, you must anticipate the increase and decrease of interest rates because both of these situations present an outlook for you to take in consideration of. A change in interest rate gives time for you to re-evaluate your strategy and how to proceed moving forward. Always set aside funds for unforeseen circumstances especially in times when you don’t expect to pay up at an instant. It is good to review your loans and what they may be subjected to. It would be beneficial to consolidate your credit, to consult about your current interest rate and possibly renegotiate to prepare for future interest rate changes.
Comparisons were summarized in the table below to differentiate certain interest rate changes.
|What happens when interest rate increases?
|What happens when interest rate decreases?
|Increase in interest rate revitalizes the value of Australian dollar.
|Decrease in interest rate diminishes the value of Australian dollar.
|Higher interest rates make home loan repayments costly and possibly harder to manage paying.
|Lower interest rates brings up home loan repayments’ affordability and easier for the debtor to pay.
|High interest rates put pressure upon the investor and incites them to save up money and analyse for future investments.
|Low interest rates persuade the investor to start new investment ventures and add more equity to their property portfolio.
|High interest rates can affect an investor’s disposable income and their short-term lifestyle by tightening funds.
|Low interest rates can be more generous for an investor’s disposable income and a liberal short-term lifestyle.
Frequently asked questions about interest rate
1. What is an interest rate?
An interest rate is the price charged to you for borrowing money from a lender. This rate is typically a percentage of the principal sum; the principal sum is the total amount of money you borrowed or money which was lent to you. The Reserve Bank of Australia (RBA) functions to issue Australian currency and sustain financial stability of the country. Thus, the interest value is directly influenced by the RBA’s official cash rate, however it is still under the jurisdiction of your bank.
2. What is fixed interest rate? What is variable interest rate?
There are two basic types of interest rates for home loans: the fixed interest rate and the variable interest rate. You are given choices of whether to choose a home loan with an interest that can change periodically or shall remain unchanged the whole duration of the repayment period. Although there are various other types, these two interest rate types are very common and all lending institutions offer them.
A fixed interest rate on a home loan is a fixed determined interest rate for a set period of time. One of its advantages is that there are no external factors that can change the rate so you can anticipate and accurately manage your budget plan over the course of time. Choosing this course may be easy, but It may prove to be hard to commit as it is also hard to switch between the fixed rate to a different interest rate type.
A variable interest rate on a home loan is a flexible interest rate that adapts to market fluctuations and the RBA’s official cash rate. One of the advantages to a variable interest rate is that it helps lighten the load of mortgage repayment when the economy is proved to be in need of restabilization by lowering the cash rate. The bank can change the interest rate, but one disadvantage to a variable interest rate is that the bank can also raise the interest rate which may be higher than the fixed interest rate.
As an investor, it is best to consider both the pros and cons of each basic interest rate type as they shall control the amount of profit you can attain in regards to your property investment.
3. What’s the difference between fixed and variable interest rates? How different are fixed and variable interest rates?
Other than the changeable and unchangeable factors, one difference between fixed and variable interest rate is their strict and liberal factors. The variable interest rate policy has a generous constituent that lets the borrower initiate early and additional repayments without any constraints or penalties. It may be beneficial to apply a home loan with a variable interest rate especially to make additional repayments to pay off a large amount of the intended loan.
Unlike the variable interest rate, the fixed interest rate policy have restrictions regarding additional repayments. The limit to fixed interest rate additional repayments is only up to $10,000 a year. Even though extra repayments are very restrained, it would also give assurance to the borrower that there won’t be any surprising increases of repayment costs. However, there is also a restriction which discourages the borrower to close their loan before the actual end of the fixed period. These are the adjustments due depending on the market conditions at the time of loan closure for interest losses to the lender and some penalty fees.
4. How are interest rates computed?
Each bank have their own policy when it comes to lending money especially for investment purposes. The banks will take into consideration the risk, the confidence and potential of the investment property. Typically, the banks analyse the cost of the property and your capacity as an investor to repay the loan. With that done, the banks can determine your borrowing capacity which becomes a margin of how much you can borrow for a loan and with how much interest rate.
Fixed interest rates are evaluated by the lending institutions or the banks themselves, no outer force can influence this value. However, variable interest rates are calculated by basing it from the official cash rate. From February to December, the RBA review the current cash rate each month. Depending on the assessment of the economy’s status, the cash rate shall either increase, decrease or remain the same. The same goes for the variable interest rate; it shall either increase, decrease or remain the same.
5. What is a cash rate?
The official cash rate is the market interest rate determined by the Reserve Bank of Australia (RBA). The market interest rate is the value that regulates overnight loans among financial institutions.
An overnight loan is a loan made by one bank to another bank for a short time frame. Every first Tuesday of each month excluding January, the RBA reviews the cash rate and determines whether it will remain unchanged or will increase/decrease the rate. Changing the cash rate reflects its purpose to develop economic growth, to sustain the current state of the economy, or to ensure the flow and stabilization of Australian currency. The official cash rate prompts banks to closely follow its trend, thus interest rates charged to borrowers rely on RBA’s cash rate. It is still under the jurisdiction of the banks whether to allow their variable interest rates to follow with the cash rate because they can chose to pass-through with their interest rates.
6. What is a comparison rate?
The comparison rate is a tool used to help identify the ‘true’ cost of a loan’.
It is also used to compare loans offered and services provided by other banks and lending institutions. Comparison rates are more helpful especially for potential borrowers because the comparison rate combines the variable interest rate with additional fees and charges related to the loan and then portrayed as a single percentage rate. The law requires all banks, non-banks, and lenders to show the comparative rate anywhere an advertising rate is specifically mentioned. This restricts them from presenting a loan as being more affordable than it is.
7. How do the interest rates fair this 2023? What is the condition of interest rates this 2023?
With steady efforts of recovering from the Covid-19 pandemic, the economy is stabilizing and so is the cash rate after it was set at an all-time low during the surge of the pandemic. The RBA started to regularly raise the cash rate mid-year of 2022 in anticipation and to counter rising inflation. Whenever the official cash rate increases, the lending institutions and Australian banks will soon adjust their variable interest rates charged to home loan borrowers. Interest rates are as healthy and strong as ever since they keep rising every month. At the start of 2023, the average mortgage variable interest rate is substantially higher than it was last year since home loan lenders are more inclined to keep the interest rate pass-through in full.
8. Can banks make cuts on interest rates?
Interest rate pass-through is described as any change in the cash rate as it transmits to loan interest rate. This means that banks have the capability to pass or project interest rate cuts in full or not pass any rate cut or somewhere in between. Any lending institution that has an interest rate lower than the cash rate can easily maintain their existing clients and borrowers, and it can also draw in new ones. Although ideal for potential borrowers, these kinds of insitutions can be stricter and can be harder for first-time borrowers to obtain a loan. It is good to always be updated with the RBA’s cash rate of the month to familiarise with interest rates and their market value. It is beneficial to obtain a loan that doesn’t have an interest rate that is above market value.
9. What is the difference between principal + interest loan and an interest only loan?
There are two basic types of loans which are the principal + interest loan and the interest only loan. When choosing between these two loans, always consider what type of property buyer you shall be, the purpose of buying the property, and financial disposition. In ‘principal + interest’ loan, the principal sum is the initial amount of money lent to the borrower. This loan gives the responsibility to the borrower that they pay off that sum plus the interest that the lender charged them. Principal and interest loan involves paying more but lowering the outstanding debt. Being able to pay off the home decreases the total amount of interest paid and the property equity grows over time.
Interest-only loans is paying down only the interest portion and any associated fees for an alloted time with a maximum period of five years. This loan is usually paid with the bare minimum, however the interest rate is higher than the interest rate of the principal + interest loan. An interest only loan is able to lower the amount owed to the bank with each payment cycle. When the period of paying interest concludes, you must begin repaying the principal + interest which will result in greater repayments.
10. When should you consider choosing an interest only loan?
Property investors who apply for loans typically avail for interest only loans since it can free up cash flow for other investments and reduce taxes on interest paid. If the property investment progresses smoothly, the loan may be repaid quicker than principal + interest loan. A principal + interest loan may be appropriate if the investment property will generate enough money to cover the entire cost of the home. But, if you won’t get the funds for several years, an interest only mortgage can allow you to acquire property today and pay off the purchase price in one go when the mortgage term finishes.