Lower Interest Rates are Coming. What does it Mean?
At its September meeting the Reserve Bank announced that interest rates will remain at 4.35%. Compared to previous decades this is relatively low. However, the surge in residential real estate values over the past 15 years and the associated increases in the size of home loans has resulted in a great deal of family pain. I have already raised the issue that it is young families with large home loans who are carrying the burden of bringing inflation under control. And again I say …. it’s not fair!
However, the future of interest rates will almost certainly be a downwards trend. The United States Federal Reserve has already reduced the official US interest rates by 0.5% bringing it into the 4.75 – 5.0% range. Importantly, it is still higher than the Australian rate. Regardless, the trend for interest rates is now headed lower.
So what happens when interest rates are reduced?
When the official interest rate is reduced, so is the cost of borrowing. This results in:
- Cheaper home loans: The decision to lower the cost of borrowing for the family home is ultimately controlled by the lender, usually one of the big banks. In the past, to maximise profits, they have often reduced the cost of their home loans by a margin that is less than the official interest rate reduction by the Reserve Bank.
Hmmmmm!! In general terms, however, a reduction in the official interest rate will eventually force lenders to reduce the cost of home loans. This is good news for anyone with a mortgage. Also consider speaking to a mortgage broker, who can assist you finding the best loan for your circumstances if your current lender doesn’t come to the party when rates do go down.
- Lower Term Deposits: As interest rates fall the interest rate that is applied to deposits will fall. Already Australian banks have begun to lower the rates on offer for term deposits.
- Consumers have greater buying power: With less of the family income being sucked into home repayments there is more money available in the family budget to spend.
- Greater borrowing power: If loans cost less, then borrowers can afford to borrow more. This often triggers another cycle of increases in the price of residential real estate. This is seen as a negative impact for those who do not yet own property.
- The value of shares increases: Lower borrowing costs mean that companies pay less to borrow funds and also reinvest in the business to increase profits. Businesses can increase spending on capital items such as buildings or new equipment or to fund expansion.
Generally lower interest rates are beneficial. They also demonstrate that the economy is past its inflationary period and is entering a new growth mode. It also brings relief to those who carried the burden of previously higher interest rates.
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