The recent interest rate drop by the RBA to 3% is the lowest level since 2000 – this could mean an early Christmas present for some…or a drop in income for others.
How the fall in interest rates over the last year affects you depends on whether you’re a borrower or a lender.
For personal and business borrowers, lower interest rates are good news because the price they pay for borrowing money should be lower. So people with a variable rate mortgage will benefit when interest rates fall (if their bank passes on the rate cut) because they’re paying less on their mortgage and have more money to spend on other things; the reverse tends to happen when interest rates rise.
While lower interest rates benefit some, they may disadvantage others. Many people use cash-based investments, such as term deposits, because they think investing in shares is too risky and want a more certain return on their investment. Unfortunately, today’s lower interest rate environment means less income for investors in cash.
For example, the average interest rate for a one-year term deposit with Australia’s five largest banks is around 4.4% (based on RBA data at 30 September). A year ago, the same average rate was 5.45%, and in September 2010 it was 6%. In just two years, someone with $100,000 in a one year term deposit has seen their interest income drop by $1,600.
For many retirees who rely on term deposits for income, falling interest rates can put pressure on the household budget and lifestyle choices. They may need to take fewer holidays and eat out less, or even be forced to cut back on necessities like food, insurance and medical treatment.
While higher interest rates are on offer at financial institutions other than banks, investing through some non-banks can involve more risk. The thousands of unfortunate depositors with the recently failed Banksia Financial Group, for example, are well aware of this risk.
The challenges of the lower interest rate environment can be managed, and an experienced financial adviser can help you make informed decisions.
By David Ramsay Certified Financial Planner