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8 Things you need to know about the latest rate cut

 

Today's decision by the Reserve Bank to cut the Official Cash Rate by 100 basis points is welcome news for both prospective and existing property owners. The combined cuts since September last year translate to a total saving of approximately $800 a month ($9,600) on a $300,000 loan. Which is like getting a pay rise of about $13,000 before tax.

 

The latest rate cut does present a window of opportunity but I suspect there will be limited time to take advantage. As other factors will also come into play. Let's look at some of the implications of this change and the strategies new and existing property owners should be acting on now to capitalise.

 

 

1. Property is turning cash positive

The combination of softening prices, strong rents and low cost of funds has significantly reduced the holding costs for investment properties. Investors who do their home work and buy well have a good opportunity to acquire property that either pays for itself or could expect to pay for itself in the short term.

 

Some investors who bought well in the last 2 years are now seeing their properties turn cash positive.

 

 

2. Improved serviceability

Reduced lending rates generally lead to reduced lender assessment rates. This is particularly good news for investors who in recent years have seen their servicing capacity diminish with successive rate increases.

 

Prior to September last year a borrower with a home loan of $250,000 looking to purchase a $300,000 investment property would have required an income of approximately $80,000. With the most recent rate cut a person would only need an income of $52,000.

 

This change means that a lot of investors who have had to sit on the sidelines may now be able to re-enter the market.   

 

 

 

3. Equity - Use it or lose it

This is one I have been stressing with clients for at least the last 12 months. Nationally average house prices have been in decline for most of 2008. While falling prices present an excellent opportunity for buyers. It also likely the level of equity available in your property has also declined over this period.

 

The table below illustrates the affect on equity from a decline in values, assuming borrowing up to 80%.

 

 

Start

5% Decline

10% Decline

Property Value

$500,000

$475,000

$450,000

80% of value

$400,000

$380,000

$360,000

Loan amount

$300,000

$300,000

$300,000

Available equity

$100,000

$80,000

$60,000

 

You can see from the table that relatively small movements in price can quickly erode equity. Which means fewer funds available to you for investment or other purposes. There is little doubt that valuers are maintaining a negative outlook at present. And as time goes on are likely to keep marking property down.

 

The message is if you are sitting on equity in your property you should be taking steps now to refinance and access this equity before it is reduced.  


 

4. Lender policies are tightening

As time goes on and economic conditions get a bit tougher lenders will continue to tighten their policies. This has already occurred with 100% loans all but disappearing from the market. This means your ability to access funds in the future may be less than what it is today.

 

Therefore delaying action may limit your options in the future. If you have plans that will require lending in the next 12 months I would recommend getting an approval in place sooner rather than later.

 

5. Paying off bad debt

By "bad debt" I mean debt that is not related to investment and wealth creating assets. Rather than spend the savings created by interest rate cuts keep your loan repayments at the same level to pay down debt faster. If you kept your repayments at the same level after the first rate cut in September you could reduce the term of your loan by approximately 16 years.

 

If you have credit cards then it worth paying these out first.   

 

6. Protect yourself

We are heading into uncertain times and employment is a concern for many people. But there are some strategies you can employ to protect yourself.

 

Get a buffer

There's a saying that the best time to ask for money is when you don't need it. As mentioned above if you are sitting on equity in your property now is the time to access it and put it aside as a buffer for a rainy day. If you do lose your job or experience a reduction of income the buffer will buy you some time to figure out what you are going to do.

 

Unemployment insurance

Unemployment insurance provides a regular income stream in the event that you lose your job which can assist covering expenses like home loan repayments. This is not to be mistaken with income protection insurance which does not cover unemployment.

 

To take advantage of this insurance you need to be employed and need to act well in advance of any cut backs at your place of employment.

 

 

7. Take advantage of changes in pricing

The global credit crisis has created significant changes in the lending market. Prior to the credit crisis many lenders were on a par in terms of pricing and product structure. But now substantial product differentiation is occurring as lenders seek to determine what type of business they want to attract. For example some lenders are offering discounts of up to 1.5% off variable rates. In short there may be a better option out there for you. This would particularly apply if you had not reviewed your loan in several years.

 

 

 

8. Fixed rates
Unfortunately with the large rate falls we have experienced many borrowers may be faced with significant penalties if they switch to a variable rate. The factors that will influence the payout figure will be the fixed rate, the loan amount, and the fixed term remaining. The higher any of these variables the greater the exit penalty.

If you are locked into a fixed rate at present the best thing to do is contact your lender for a quote on what exit penalties would be involved. Even if you are on a fixed rate there may be a number of options available to you.

         Many fixed rate loans allow some level of prepayment without penalty. In some cases up to $10,000 to $15,000.

         Some fixed rate loans offer a partial offset account. This is different to a full offset account but can still offer some savings.

 

In the above cases you could establish a separate variable rate facility and pay funds into either the fixed rate loan or the offset account. By doing this you are effectively transferring some of the debt to a variable rate without breaking the loan.

It may also be a case of doing the maths on the exercise to weigh up the long term costs and benefits. Breaking the loan now might be costly, but there may be overall savings and improved cashflow in the long run. Particularly if rates fall further.   

Your next step

To find out how the above information applies to your specific situation your next step  is a simple one. Just complete and return our Customer Action Form  or call us 07 3666 0110 to arrange an initial finance review.