In its first board meeting of 2021, the Reserve Bank of Australia (RBA) decided to keep the cash rate at a record low of 0.1%. Find out why rates are so low and what it may mean for you and your financial goals.
Why does the RBA keep rates low?
Lower interest rates and rate cuts are a way for the RBA to help stimulate the economy. The idea is, when the official cash rate is low, banks may follow suit and lower interest rates on the loans they provide.
When rates are lower, you pay less interest on your debt, freeing up money for you to spend elsewhere. You may also be more likely to borrow money. This increased spending has a ripple effect through the economy, giving it a boost.
It’s important to note that when the RBA cuts the official rate, or keeps it low, there’s no guarantee that the banks will do the same. For example, in recent times, some banks have only passed on part of the rate cut.
In a statement from the RBAi, they advised they will not increase the cash rate until inflation is within the target range of 2-3%. For this to occur, wages growth will have to be higher than it is currently, requiring significant gains in employment and a return to a tight labour market. The RBA isn’t expecting these conditions to be met in Australia until at least 2024.
What could low interest rates mean for me?
So, it looks like low interest rates may be around for a while. This could be good news or bad news, depending on your financial goals. Here’s what low rates could mean for four common financial goals:
Paying off debt
If you have a variable rate loan, a rate cut can work in your favour, provided your lender passes on the cut. This could be a good opportunity to start clearing debt. One strategy to consider is to keep your loan repayments the same despite the rate cut, so that you pay off more of your loan, faster. Or, you may consider using the money you save on repayments to invest elsewhere to help grow your wealth.
It generally makes sense to pay off bad debt first (ie debt used to pay for day-to-day expenses like credit card debt, rather than debt used to pay for an income-generating asset like an investment property). It’s also usually a good idea to start paying off the debt with the highest interest rate first.
If you have a fixed-rate loan, it may be a good time to crunch the numbers to see if refinancing is worthwhile, so you can take advantage of the lower rates on offer. When you’re working this out, make sure you factor in, not only the amount you could save on repayments, but also the break costs associated with the current loan, as well as any set-up fees associated with the new loan.
It’s important to consider your circumstances and goals before deciding what’s right for you, so financial advice may help.
Buying a property
If you’re in the market to buy a property, a reduction in interest will probably be welcome news. That’s because lower rates will influence how much you can borrow and how much you can afford to repay on your loan.
While it may be tempting to borrow more, keep in mind that interest rates will eventually increase and so will repayments. It’s a good idea to check whether you can afford the home loan if rates were to go up.
Increasing your savings
A low-rate environment is generally less favourable for savers with cash in the bank and may prompt some investors to consider whether their money could be working harder for them elsewhere.
With little interest to be earned by keeping money in the bank, alternative options such as income-generating shares that pay attractive dividends may be worth a look.
Before making any changes, it’s important to understand the risks involved. Shares, for example, are much riskier than keeping money in the bank. But they may offer the potential for much higher returns than a cash deposit.
Other options which may help your money to work harder for you include managed funds or property. Again, these investments carry more risk and can tie-up your cash for a longer period of time. Also be sure to understand any fees involved.
Growing your super
This is a timely reminder to check what portion of your super is invested in cash. Consider whether the amount of super you have in cash is still appropriate given the level of risk you’re comfortable with and the time you have left until you retire.
Ultimately it comes down to what’s important to you, what stage you’re at in life and how much risk you’re willing to take on for potentially higher returns. If retirement is still a while away, you may consider taking on riskier, higher growth investment options like shares or property that have the potential to help grow your super balance over time. However, if you’re retiring soon, you may not be as willing to take on too much risk, as preserving your super balance may be a higher priority. We can help you make the most of this low interest-rate environment and stay on track to reach your goals.
i RBA website – Supporting the Economy and Financial System in Response to COVID-19
©AWM Services Pty Ltd. First published February 2021