Rising Interest Rates
How to evaluate the effect
The RBA raised interest rates by 0.25% in May and a further 0.5% in June. The RBA suggests that there are likely to be more increases in interest rates.
With interest rates having been kept low since the GFC and now with inflation on the rise it should be no surprise to anyone that increasing interest rates to long-term average rates is a highly likely scenario.
The RBA released a statement after its June 7th meeting. For those who want more information, consult the Statement by Philip Low, Governor on the Monetary Policy Decision. This may help you form a personal view on the likely changes in both interest rates and inflation.
The final summation from the statement was:
The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market. The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.
The popular press seems to think most people have been taking advantage of the lower interest rates to repay their debts faster. In addition, banks have been raising the benchmarks when assessing new borrowers’ ability to pay with higher interest rates. Hopefully, most people, have been taking a sensible view of their debts and will not suffer financial stress due to the recent interest rate rises.
However, predictions are that interest rates are likely to rise further, and could reach the point when the increased rates do cause financial stress for some. This graph shows the average standard variable home loan rates between 2000 and 2021.
Current Inflation has risen to over 5% in the last 12-months. This graph shows the average inflation between 2000 and 2021.
The RBA statement estimated that by raising interest rates, inflation would return to the target rate of between 2% and 3%.
How to calculate the effect of rising interest costs with Financial Mappers
With Financial Mappers, there are several tools to assess the effect of rising interest costs. The Debt Management Report will show the effect of raising interest rates by a nominated percentage, say 2% over the next 5-years.
In this example, there is only one home loan and no additional loan payments have been planned. Note that the monthly increase is $221.00.
Financial Mappers has a comprehensive set of Modelling Tools.
The Loan Modulator can be used to assess the effect of rising interest rates.
In this example, the Variable Interest Rates, rise by 1% in the first year and then 0.5% each year, until they have increased by 3% from the current rates.
The Loan Modulator includes a graph of the Indicative Effects of Interest Rates on a $100,000 loan.
A second option would be to consider the cost of your current loans if you were to select a historical period where loans rates were higher.
For example, between the years 2000 and 2008 the average home loan cost was 7.4%.
Why you need a Financial Plan
Not only are loan costs likely to rise, but it is predicted that energy and fuel costs will rise, in addition to our everyday living expenses.
Now more than ever, it is the time for everyone to make a Financial Plan. This will allow you to calculate where you can make savings in your Living Expenses and how you can better manage your debt. If you can afford it, now may be the time to seek expert financial advice.
If you are a DIY investor consider watching this video, Why you Need a Financial Plan.
Glenis Phillips SF Fin – Designer of Fin
Disclaimer: Financial Mappers does not have an Australian Financial Services License, does not offer financial planning advice and does not recommend financial products.
