What would you do if interest rates rise?
What will you do if interest rates rise? What period should you fix for?
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No one has a crystal ball or knows exactly when interest rates will go up or by how much. But it is important to have a plan and consider the options for you.
- US inflation article last week, “Warning mortgages could see 56% increase if US inflation scenario plays out”
- RBNZ monetary policy announcement today.
- Most economists expect increase mid-next year
- Tony Alexander comments “They will (come 2023-24) raise interest rates as high as necessary to contain inflation. Be sure you build a high interest rate scenario into your planning for the next five years, so you are prepared for if they take rates to a level you currently do not expect.”
- 5 years 3.39%. If you are on a low income and would struggle if interest rates rise, then you need to consider having some 5 year for long term protection. This would be a more conservative strategy but if money is tight, having security of payments for the next 5 years can put you in a safer position.
For others not on low income. From a quick glance, the 5-year rate appears to be more expensive than sitting on the 1-year rate for each year. This table shows that if 1 year interest rates were to go up 0.6% each year, the average over 5 years would be 3.45% which is higher than the 5-year rate of 3.39%. Do you expect 1 year interest rates to go up to these rates and higher?
If yes, then 5 years makes sense.
Another option – spread your risk, have some 5 year and some other rates. This is unlikely to give you the best result, but by spreading you are taking less of a risk.
- 2- and 3-year rates. Why?
No long-term protection as too short. 2- or 3-years’ time is going to be 2023 or 2024, right when Tony Alexander is saying that interest rates might be higher. So, coming of a fixed term then might mean the new rates to fix at are higher.
2 year 2.59%. If we compare to 1-year rates. If first year is 2.25%, the second 1 year fixed would need to be 2.92% to average 2.59% over the 2 years. Do you expect 1-year rates to be over 2.92% in 1 years’ time? If so, then a 2-year rate would make sense. If not, then a 2-year does not make sense as would not be the best rate (using your predictions) and wouldn’t give long term protection.
If you were worried about long term protection, better to look at longer term rates. 3 years could give some protection, but 5 years is likely to be more effective.
- 1 year at 2.25%. In the recent past 1-year rate has given the best interest rate, but there is no guarantee that will happen in the future. Taking 1 year is the aggressive approach and works well if you have the income to support the gamble. If interest rates go up you need to be able to pay for the increase.
1-year rates will give you the lowest interest rate for the first year, but only time will tell how it performs over the next 5 years.
Buffer – In my opinion it is really important to have a buffer to make sure you can easily get through the next property cycle. Property investment is all about the long term and you need to be able to hold the property long term to do well. No one has a crystal ball, but property has been too good in the past few years, so one possible outcome is a flatter period for the next few years. So rather than gambling on property booming, have a buffer and some backup plans just in case it does not.
Free chat – a great way to discuss interest rates, loan options and much more is a free chat with our team.
For any clients we can also email through the spreadsheet that compares interest rates. 1 year vs 2-, 3- and 5-year rates.
Latest video – Case study example from a real life example last week, of how could restructure to save over $16,000 in tax. This example is for commercial but could potentially apply to new builds and trading.
Property Accountant | New Zealand
Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular person's objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.
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