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Investopoly
Each episode is packed with concise tips, strategies, research, methodologies, case studies, and ideas to help you safely and effectively grow your wealth. Stuart Wemyss, a qualified financial advisor, accountant, tax agent, and licensed mortgage broker, delivers holistic advice. With four authored books, including "Investopoly" and "Rules of the Lending Game," Stuart shares his insights through a weekly blog, which is replicated on this podcast.
Investopoly
Surviving the high interest rates: tips to navigate the next few months
Read the full blog here.
How long can we expect the current high interest rates to stick around, and what can we do to navigate this challenging financial climate? I share my insights and tips on managing debt and restructuring loans to soften the blow of rising rates, while also taking a look back at interest rates over the past 40 years to make sense of the current situation.
As we explore the impact of these higher rates on consumer spending, I also discuss how Australians have been taking advantage of lower interest rates by building up their buffers and reveal the surprising reasons why people with higher incomes have benefited more from low rates than those with lower levels of debt. Plus, I share two enlightening CBA charts that paint a clear picture of what's to come. Don't miss this essential episode to help you stay afloat in the rough waters of today's financial landscape!
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Hi, this is Stuart Weems and welcome to the Investopoly Podcast. My goal is to give you simple, easy to understand strategies, insights and tips to help you master the game of building wealth, and in this episode I'd like to talk about my tips for navigating higher interest rate periods. Exactly like we are in at the moment, and particularly if you've got some fixed rate loans that are maturing soon, certainly you'll experience a much higher fixed rate period. So, of course, as long term borrowers, either as investors or own occupiers, we know that if we have mortgages for a few decades, which most people will, particularly property investors over that time there's going to be periods where interest rates are above average And, of course, periods of time when interest rates will be below average, as we've just experienced through the pandemic period. If you have a look at the average standard variable rate since 1959, that's when the data set began, so more than 60 the past 60 years the average standard variable rate is 8.2%. Now most people able to get at least a 2% interest rate discount off the standard variable rate. So that puts the average standard variable rate around about 6.5%, which is what I've always done my numbers at, in terms of either advising clients or considering my own borrowing plans, i've always made sure that it's affordable around 6.5% 7%. So on average over a long run, that's what we probably should expect to pay. But of course, as I said, there's going to be periods of time when interest rates are above that level and then periods of time where they're below that level. So, of course, interest rates are used as a monetary policy tool to either expand or contract an economy, and so interest rates are used to call the economy just by calling consumer demand. Obviously, the more interest you pay, the higher your repayments are, the less money you've got to left over to spend, which, as I said, a lot of people are experiencing.
Speaker 1:I've spoken in this podcast many times over the last 12 months and I expect discretionary expenditure in Australia to dramatically fall, particularly over the next six months, as more interest rates roll over from very low fixed rates onto very high variable, much higher variable rates. But interest rates don't have to stay high for a very long period of time in order for them to do their work, particularly given that Australia has higher levels of indebtness today than they did 10, 20, 30, 40 years ago, and so what I thought I would do is I have a look at the last sort of 40 years of data and had a look at how long do interest rates remain at their peak? So, obviously, interest rates are increased to call an economy. How long does it take to actually call that economy? And if you have a look at the over the past 40 years, the time that interest rates remain at their peak is somewhere between four and 16 months, with the average time being 10 months. So when we Think about navigating higher interest rates today, we don't have to make friends with navigating those interest rates for a very long period of time. It's likely that all we need to do is get over this hump of this above average interest rate period so that we can get on the other side to a more sort of normal interest rate level. And if you factor in the higher end household in-debtness, it's more likely that interest rates will remain at their peak for maybe four to six months. It could be nine months, probably not likely. So therefore, we're probably looking at lower interest rates in 2024, which many market commentators agree with.
Speaker 1:So then, for the rest of this episode, what I'd like to talk about, then, is what can you do to sort of get through this period, if we realize, or at least acknowledge, that it's going to be a relatively temporary period of above average interest rates. What can we do to get through these periods? Well, the first thing is, hopefully most borrowers have taken the advantage and they certainly have looking at data, but most people listening to this podcast hopefully they've taken advantage of below average interest rates over the last couple of years And, as such, they've been able to build up their buffers Buffers in terms of cash savings or cash savings in offset accounts or making additional repayments. So you've got access to redraw. And it certainly reflects in the data that Australian households have savings equal to 20% of their annual income. So Australians have accumulated a lot of savings, particularly those that are on higher incomes, because they've had the benefit of these. People with higher incomes tend to have higher amounts of debt as well And therefore they've benefited to a much greater extent because of lower interest rates than people with lower levels of debt and, as a result, have a greater savings capacity.
Speaker 1:Now I've made the point in this podcast a number of times that interest rate expectations can change very, very quickly, almost overnight. It is literally. You go to bed one day and people think interest rates are going to be higher for longer and you wake up tomorrow morning all sudden interest rates are going to zero again. Those expectations can change very quickly And all we have to do is look back at the last 12 to 18 months to sort of realize that again. 18 months ago There were some economists and commentators talking about well, maybe interest rates will be at sort of zero levels for a long period of time many, many years. And here we are today where the cash rates have been increased by 4% over a relatively short period of time. So therefore, once we see inflation get under control, it's likely then the market will change in terms of their interest rate expectations and start factoring in cuts.
Speaker 1:The point of having savings buffers is so we can use them during periods of time where interest rates are above average, and quite often I find people are really reluctant to dip into savings. It's kind of like, oh, it's the last thing they really want to do. But that's the whole point. Savings are there. That's why we have financial buffers. So if you do need to rely on financial buffers to get you through this period of above average interest rates, then certainly do that. That's what they're there for.
Speaker 1:The next thing you could do is reduce discretionary spending, and if you have a look at where inflation is centred, inflation has really been centred in above average demand for services as opposed to goods. At the beginning of the pandemic, everyone was spending on goods and demand was there. Now it's really services. So things like holiday, travel, medical services, rent, restaurant meals they all go into the category of services within CPI. That's the inflation measure. Now, of course, some of those things are discretionary items, like holidays and restaurant meals and so forth.
Speaker 1:So of course, the first thing we must do is start cutting discretionary spending to get us through those periods of above average interest rates, and the best way to do that is again I've spoken to about this a number of times. I've got a link in the show notes, of course, as I usually do the best way to do it is to pay all discretionary expenses from one particular bank account, and so what you do is you transfer every week, month or fortnight a certain amount into this discretionary spending account and then you use that for all discretionary expenses, non-discretary expenses like utilities, electricity, so forth, school fees, mortgage repayments, insurances, all the stuff that you can't really overspend on. They can come from a different account, you don't need to worry about them so much. It's really the discretionary element, and so the best way, then, to reduce your discretionary spending is by quarantining one account and reducing the amount that you transfer every period of time I said week, fortnight, month and therefore you're able to reduce your spending.
Speaker 1:Of course, you could explore ways to increase your income in order to get through this period. That could include looking for a new role with your existing or new employer, increasing the amount of time that you work, so, if you're part-time, increasing the number of hours, retraining, getting a second job, doing all those sorts of things. I guess the point is that the labour market is incredibly tight, And if there's been any time to increase your income over the last 20 years, now it's really the best time to do it, given the tight labour market. So that's something you can think about, and I know I've been having conversations with some clients around borrowing capacities and they're starting to think about. Well, you know, is there anything I can do career-wise in order to extend my borrowing capacities, to put me in my self-indulged position where I'm able to build more wealth than what I would be able to do in the absence of that, next thing to do is think about any really expensive financial repayments or commitments So things.
Speaker 1:If you're younger and you've got a hex slash help debt that they can be quite expensive. You can end up paying. You know, if you earn more than $150,000, you've got to pay 10%, repay 10% per year, which on an after-tax basis is really 14% of your take home income. So it can be really exhaustive, whereas if you've got some savings in a bank account, you might be actually better off just repaying that debt. Similarly, with car loans and so forth, they tend to be on short loan periods, and so the repayments can be quite high. So sometimes just paying out a loan using cash from a cash flow perspective is a good thing to do or certainly help you through that period of time.
Speaker 1:The next thing you could do is consider restructuring your loans. The shorter the loan period or the deeper that you are into a loan contract, the higher the repayments. So, for example, if I established a million dollar loan 10 years ago and it's just converted to principal interest, just because I've had sort of two five-year interest only terms, my repayments are going to be close to $7,500 a month. And that's because those repayments are spread over, the remaining loan term being 20 years. However, if I reset the loan term today back to 30 years by refinancing with my current or a new lender, my monthly repayments can reduce to about $6,300. So about $1,100, $1,200 saving per month just by resetting that loan term even and still remaining on principal interest repayments. So restructuring your loans existing loans can be a way to sort of get through this period of time in terms of reducing your minimum repayments.
Speaker 1:Now I've spoken about some things, some tips here to get you through this period of time, but I think also, for some people, it's important to face the brutal truth. And if you have borrowed to an extent where it's unaffordable, if interest rates remained at 6 or 6.5%, sort of around that vicinity, for a long period of time, then chances are it's indication that you have borrowed too much, you've over borrowed, and so if you don't think you can serve a state at that level, you are going to have to make some changes with respect to the amount of borrowings that you've got And therefore it's really important that you start formulating a plan to deal with those debt levels. Ignoring it, putting your head in the sand, isn't going to be the right thing. You're going to want to be in a position where you can take proactive steps in your own time, in the way that you want to do it, rather than leaving it too late, getting in trouble and then the bank might force you to take those steps at their pace, in their way of doing things. And, as the saying goes, if you find yourself digging a hole, stop digging. So I think there's going to be some people hopefully no one that's listening on this podcast, and I think there's going to be some Australians out there that have over borrowed, that have overextended themselves, and they're just better off to come to terms with that, whether their situation has changed since making that decision in terms of borrowings, or whether they were a bit silly and borrowed too much to begin with. You're better off to make friends with that. Come to terms with that as soon as possible.
Speaker 1:Now in the blog on the website, i share two really important charts that CBA released last week and I think it really illustrates what's going to happen over the next 12 months. One chart shows that most fixed rate terms will expire this calendar year, so over the next six months, i think we're really going to see interest rates have a much greater impact on spending consumer spending than what we have over the last six months, just because a lot of people are rolling off, and that's quite a compelling chart. The other chart that I've included in the blog on the website shows that there's a big gap. There's a lag between interest rates going up and principal interest repayments being recalculated by the lenders. So the lenders will pass on higher interest rates, typically one or two weeks after the RBA has hiked interest rates, and that's what usually happens. There's no exceptions to that.
Speaker 1:However, if you have a principal interest loan, the dollar value of the loan repayment won't necessarily change because what the bank does is have to recalculate that repayment based on the remaining loan term and the prevailing interest rate at the time. They don't do that every month, and so there can be a two to three month lag between interest rates increasing, that the interest that the borrower pays increases one or two weeks after the rate is hiked, but the dollar value of the repayment might not change for two or three months after that period of time. So really, what we need there needs to be a little bit of time that elapses, and the chart shows is the difference between interest charged and the repayments, and we can see that it hasn't increased, that that effect of higher loan repayments hasn't really been felt, even by variable interest rate borrowers. The upshot is that consumer confidence and consumer spending is going to fall off the face of a cliff, i think over the course the remainder of 2023, and I think that will more likely curtail inflation. Hopefully fingers crossed and that by the time we get to the next year, the interest rate expectations will change dramatically.
Speaker 1:Now I wouldn't bank on that. As I said, you need to be able to afford or get through this higher interest rate period for longer than that, but I think that's the most likely outcome, and so obviously, what that's going to do is eat up some of that spare cash flow that a lot of borrowers have enjoyed through 2020 and 2021. And, unfortunately, they're just going to have to recalibrate their spending, recalibrate what debt costs these days and get us also into a position where that normalizes. So hopefully, today's episode gives you a couple of tips on how to get through this higher interest rate period, puts it in perspective to help you understand it's not going to be forever and how important it is to make sure that borrowing safely and not over borrowing is incredibly important to do. Mortgages are a wonderful servant but a terrible master. Okay, that's it for me this week, until next week. Bye for now.
