You would be excused for thinking that developed economies all over the world are gradually making their way to a zero interest rate environment.
Long term fixed mortgage rates in the United States are less than 3% p.a. In the UK, rates are under 2% and even lower in Europe (circa 0.50% p.a. in France for example). In Australian this week, 5-year fixed home loan rate fell below 3% p.a. And in Demark the other week,
Jyske Bank announced it would pay borrowers 0.50% p.a. to take out a mortgage! Anyone that had a mortgage in the early 1990’s would regard today’s interest rates as almost unfathomable.
What does this mean for investor, especially those that borrow to invest in property?
Interest rates lower for longer?
The market is
predicting that the RBA will cut rates by 0.50% by mid-2020. If this turns out to be correct, Australian mortgage rates could fall even further.
In July, RBA Governor,
Phillip Lowe said "Whether or not further monetary easing is needed, it is reasonable to expect an extended period of low interest rates." Many commentators have suggested that interest rates may not increase materially for a decade or longer. Japan, for instance, has been stuck on zero interest rates for 20 years.
But the banks need to charge at least 2%
A measure called the ‘net interest margin’ is the gross profit a bank makes from lending money to its customers. The net interest margin must cover all the banks costs and still deliver a healthy net profit. In Australia, the major banks net interest margin is approximately 2%.
Therefore, even if Australia’s cash rate fell to zero, it is unlikely that variable mortgage rates would fall below 2%, as the banks would seek to maintain their profit margins. Of course, a negative RBA cash rate, which exists in some countries in Europe, could push variable mortgage rates below 2%.
Bye, bye negative gearing tax benefits for property investors
The most obvious consequence of low interest rates for property investors is that it significantly reduces negative gearing tax benefits. When interest rates were 7% p.a., property investors where crystallising large income losses. That is because the interest costs and property expenses were a lot more than the property’s rental income. The investor could offset this loss against employment income and enjoy a sizable tax refund (which is referred to as negative gearing).
According to CoreLogic, Australia’s gross rental yield is 4.1% p.a. Compare that to the current interest only investment mortgage rate of circa 4.5% p.a. and you will see why an investment property’s income loss today is only 40% what it was when interest rates were much higher. As a result, taxation benefits derived from borrowing to invest in property are consequently 60% lower.
In a low interest rate environment, saving tax is no longer a big draw card for prospective property investors. This is a good thing as you should never invest predominantly to generate tax benefits. However, if you were banking on your property investments helping you reduce your tax liabilities, think again.
Don’t use your own money
In a low interest rate environment, using your own cash carries with it a higher opportunity cost. That is, you must consider what investment returns you can generate by investing your cash elsewhere (and using borrowed funds instead). If you believe you can achieve an i
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IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.
