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Residential Property Investing – What if Interest Rates Goes Up?
By Yong-Long Lai
Okay, Here’s the first one of the fears!
What if Interest Rates Goes Up?
If you are scared of interest rates going up then the solution is to fix it. Just remember that interest rates can both go up and down. Fixing the interest rate reduces 1/2 your risk (ie. it reduces the risk that you will have to pay more interest in the future) and guarantee that your interest expense is constant over the period. Obviously if interest rate drops and you fixed it then you won’t get any benefit of the interest savings. A suggestion is to fix half the loan so that you can get 1/2 the benefit of interest movement in either direction.
Fixing interest rates will only guarantee that your expense is known (ie. it will not increase or decrease). The factor to note when fixing your interest rates, especially in the more recent economic time (2008) when interest rates all over the world has dropped dramatically, is that fixed rate break cost will go up approximately proportional to the interest savings from the rate drop.
Example:
Loan Amount: $300,000
Fixed Interest Rate: 8%
Fixed Term: 2 years
Current Interest Payable: $24,000
If interest rates dropped 2% from 8% to 6%, a person on variable loan would save $6,000 (2% x $300,000) in interest payments (ie. instead of paying $24,000, they would now pay $18,000 @ 6%)
If you were to break your fixed rate loan with 2 years remaining, a fee of approximately $6,000 x 2 years = $12,000 would be charged to break out of the fixed rate loan. This would effectively make breaking your fixed rate loan not worthwhile. (Note: the actual break fee depends on the prevailing cost of funding for the bank and not the interest rate that is advertised on the loan, though it is a good approximation)
The upside here is that when the bank gave you the loan at 8% you were able to service the debt and if your financial circumstances hasn’t changed, then you would still able to service the debt without. Personally, the large interest rate drops have affected my fixed loans and there is not much I can do about it. That said, if I had a choice to rewind time, I would have fixed my loans. Personally I prefer the certainty of knowing that my expenses are fixed than hoping for a chance of interest rate drops.
Here’s a link to some resources on Real Estate
Your Success Club > Articles > Residential Property Investment - Barriers > What if Interest Rates Goes Up?