Interest Rates
Almost everyone is interested in interest rates, whether it be how much you are paying on your mortgage or how much you are receiving on your term deposit. Everyone also has an opinion as to whether interest rates will go up or down, but in reality it is very hard to predict as interest rates are dependent on many things:-
The supply and demand of credit - how much money is available in the system
Inflation - the higher the inflation, the higher interest rates are likely to rise
Government announcements on policy
Global interest rates and foreign exchange rates
Interest Rates on Loans
What are some of the things that you should be thinking about next time you look at your bank loan and interest rate?
Should my interest rate be floating or fixed?
The most important thing in deciding on whether to have a floating or fixed rate is how strong your cash flow is. If your budget shows that you have limited free cash flow after paying your debt then you should look to fix your interest rate. This will protect you if interest rates rise and you are able to “weather the storm.” If, on the other hand, you have strong cash flows with plenty of headroom, then you may decide to have a floating rate. This will give you more flexibility, you can take advantage of any interest rate decreases and because of your strong cash flow you will still be able to service the debt if interest rates rise.
Is there a penalty if I have to break a fixed rate loan?
Yes, in most cases. Assume the bank has agreed to lend you some money at an interest rate of 5% for 12 months. In six months the interest rate has fallen to 3% and you want to break the loan. If the bank agreed to this then they would only be able to lend the money to someone else at 3% for the remaining 6 months, hence they would charge you this difference as part of breaking the loan. If on the other hand interest rates had risen to 7% they might agree to break the loan as they could then lend the money to someone else at 7% (instead of to you at 5%).
Should I pay interest and principal on my loan?
If you have money in your account then the majority of people will spend it. One of the best ways to save money is to remove that money from your account as soon as it gets into your account. A mortgage payment going out of your bank every month (or sooner) is an ideal way to “save” you from spending it. The obvious benefit is that your equity increases as you repay the debt. Often banks will provide you with a 25 or 30 year loan, but if you can I would structure the loan so that you can make earlier repayments using any excess cash you have. In some cases you might have an interest only period and that is again dependent on your cash flow and budget.
In summary:
Your cash flow drives most investment decisions.
Interest rates go up and down. You will never get it perfect but do your homework, know your cash flow and then make your decision.
Talk to people about this. Everyone has a view which will help you form yours.
James
Image source: https://www.nzadvicegroup.co.nz/blog/post/20437/The-Rise-and-Fall-of-Interest-Rates/