An Australian Horror Story: Low interest rates?

To the point of nausea, I endure while people talk about low interest rates, with intensity and excitement.  My fear is that young people in particular fall for the low interest rates equal good news paradigm.  To put it in common language, I fear that young people will believe their elders, when they spout that low interest rates are exclusively a good thing.

Let's have a look shall we?

1) Low interest rates make it difficult to save

Why save when your return on savings is low?  Low interest rates affect your savings by reducing return on them.  When interest rates are higher you can save more, faster.  That includes saving up for a newer car or a house deposit.

Yes, do save but it's much harder to do so.  Equally, retirees can not live on savings for as long as they would have been able to in the past.

This costs us all more, as there are more people at risk of financial hardship, even responsible types.

The flip side?  Higher interest rates make it easier to save and retire earlier and in comfort.

2) Low interest rates are a sign of a dying economy

The reality is that the Reserve Bank reduces interest rates primarily to encourage economic activity.  In other words, reducing interest rates, means that the economy is in a less than favorable spot and is likely to stay that way unless the Reserve Bank can encourage us to spend, spend, spend.  That's the theory anyway.  I think more emphasis should be on saving.  It seems to me that interest rates go down and there is negligible benefit at this point because they are already so low.

The flip side: Higher interest rates traditionally indicate more people in secure and full employment, they usually mean more national savings and they reward responsible behavior.

3) Low interest rates mean you pay more for older houses

Newer houses are a reasonably set cost because they are based on the current cost to build.  The only wriggle room in price is in the land value.  Not only does low rates mean that price inflation is encouraged, it also keeps houses in the hands of people who would otherwise sell.  It inevitably increases the renter pool.  This is only reduced at the moment by the poorer end of town sharing housing, mainly multi-generational living, which is growing.

There is some evidence to suggest that the low increase in interest rates for investors is encouraging real estate listings for sale.  The more houses on sale, eventually, with increases in interest rates, the house prices should go down. Add to that more people selling houses when they enter nursing homes and an increase in deceased estates and you have the perfect storm for older house prices to go down.

The flip side: higher interest rates expose lenders to financial stress if they took on high mortgages.  In time history shows greater rates of defaults and price reductions.

4) In a low interest environment mortgages are not cheap

Certainly, low interest rates mean you pay less for your mortgage than if interest rates were higher per dollar.  With the
average median Australian house now around $660,000 AUD,

based on interest rates of 4% at the bank (lowest currently on offer I could find rounded up, 3.99 was the lowest),

and with a decent deposit of 60 000, based on a principle and interest mortgage, over 30 years,

you pay the bank, $471, 958 in interest.  In interest.  Oh yes, bargain (sarcastic tone - dripping in it).
That's the value of compound interest.

You also pay $25, 048 in stamp duty.  The higher the value of the house you buy, the higher the stamp duty, hardly surprising government's do not want house prices to go down.

The mortgage calculator I used adds in a contingency of $20 000 in case of emergencies.

And, without a twenty per cent deposit, you are obligated to pay mortgage insurance, in this case, that comes to $11 640


To give you an idea,

the same interest rates and conditions, on a much lower, some might say unrealistic amount,

with a deposit of $20 000 and a house price of $110 000,

the interest you pay is $98, 040


I remain unexcited about low interest rates.  I believe they are very bad news indeed.  I would like to see interest rates lifted so that savers are encouraged and rewarded, people can buy and keep a home.

Australian house prices:

Disclaimer: While I have done the best to base this on history, and my understanding of the economy, this is the writer's opinion only.  For factual analysis contact a finance professional.

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