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The era of cheap loans is ending

Following COVID-19 lockdowns, floods, and the turmoil in Europe, consumer sentiment is already falling. Now with the rising cost of most goods adding to inflation, increases to interest rates are likely, leading the Reserve Bank of Australia (RBA) to raise the cash rate in an effort to control inflation, which is anticipated to come as early as the beginning of June.

After more than 10 years of reductions in the RBA cash rate, there is a sentiment in the market that Australia has been lulled into a false sense of security. The cash rate last peaked at 4.75% in November 2010, however, it’s been downhill since then, with the rate now at 0.10%.

When will rates rise?

ABF media

The market offers differing views on when rates will rise. The RBA has held a relaxed stance, repeating again on 1 March that they won’t raise the cash rate until “inflation is sustainably within the 2 to 3 % target range” but their definition of ’sustainably’ is open to interpretation.

The ASX produces data showing an implied yield curve based on the futures market, that is, the market’s near term predictions of the likely RBA cash rate. Data taken on 31 March 2022 showed an implied cash rate of 1.00% in September 2022, and over 2.00% in March next year. From the current rate of 0.10%, this suggests that the interest paid on many loans a year from now could be almost double what it is today.

What are we seeing?

While there are still variable home loan rates in the low 2.0% to 2.50% range, fixed rates are skyrocketing based on the banks’ belief that rates will rise. Last year there were fixed rate loans for up to 3 years for less than 2.0% but it is now difficult to find one for less than 3.5%.

For businesses, the story is largely similar. Currently, variable rates and margins are still at very good levels and equal to the best we’ve seen in years, but we’re starting to see increases for longer term loans, and again for fixed rates.

Bank funding costs are also rising. The low interest bank funding offered by the RBA’s special Term Funding Facility must be repaid soon. This cheap funding was provided to help banks lend cheaply through the COVID-19 crisis, but further funding through this facility is now gone. As the banks repay these cheap loans they’ll have to replace them with more expensive funding in the market, meaning there is a risk the interest rate that consumers and businesses pay will increase by an even greater level than the RBA cash rate.

ABF media

In the coming months, consumers and businesses should expect to see their interest rates rise, either in line with the cash rate moves of the RBA or out of cycle by the banks.

What are your options?

BDO recommends the following options to better protect yourself from these changes.

  • If your financial position has improved since you last spoke to your bank, arrange to talk to them. You may be eligible for a lower interest rate which will offset some of the potential cash rate rises
  • Don’t pay for things you don’t need. If you can simplify your arrangements or reduce your loan, we recommend working on this as soon as possible. Even if you can’t pay down your loan today, achieving a reasonable reduction in the next 12 months will shield you from some of the pain of rising rates
  • If you expect your financial position to tighten up in the next 12 months, address the issues. If you need more headroom in your loan or your working capital facilities, have that conversation with your bank now before the situation deepens
  • If you are looking to borrow more money for your next purchase or expansion, think about the structure of your loan arrangements and how to efficiently access the cheapest form of funding available.

BDO’s team of experts are well equipped to assist you in reviewing your loan facilities. Reach out to our Debt Advisory and Finance Solutions team for a consultation.

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