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Cashing In On Interest Rates

Interest rates are historically low, so how can you make the most of them? Amy Hamilton Chadwick reports.

By: Amy Hamilton Chadwick

31 May 2016

If there’s one thing all our experts agree on, it’s that interest rates are definitely going to go up. At some point. But not soon. Also, they could very likely go down before they go up again. Interest rates will definitely either go down, or up, at some point.

So now that’s clear, what strategies can you use to take advantage of the lowest interest rates New Zealand has ever seen?

We spoke to investors, mortgage advisors and economists to find out what uses these low rates are being put to and what the forecast might be for the lending environment. Strategy: time to buy

The most exciting strategy is to use cheaper leveraging to expand your portfolio. Lower yields are the new normal and previously cashflow negative properties are now covering their costs – rising property prices are in part an adjustment to the reduced cost of borrowing.

In 2011, Kyron Gosse purchased a negatively geared house in Paihia only to see values drop.

“It really hurt,” Gosse said. “I bought that before I knew anything. I tried to sell it, lease option it, everything – the market had tanked. Now the rent has gone up $20 a week and I’ve locked it in for two years. Finally, it’s come positive and it’s now worth what I paid for it.”

Having sold several properties, he’s out buying again and meets many other busy investors with money to spend. When we spoke he had just put an offer in on a five-bedroom house in Whangarei, “at under $300,000. I’ve watched how people have gone from buying only in Auckland to no-one buying in Auckland.

The rest of New Zealand is still so affordable.” Gosse’s strategy is to use the low interest rates to buy neutral or slightly negatively geared property. By fixing at the lowest rates he can, Gosse believes the rents can be increased over the term of the loan so that “by the time the rates go up it’s looking after itself ”.

Areas Becoming Affordable

Because cashflow negative properties have turned into neutrally geared ones, some investors can now buy more expensive, lower yielding properties with an expectation of higher capital gains in the long run, Maree Tassell, sales manager at iFindProperty, says.

Her clients have been able to buy in areas they wouldn’t normally be able to afford, she says, like the $1 million-plus suburbs of Wellington.

Pay down as much debt as You can because if it does Collapse it’s not just Higher interest rates You have to cover, it’s Also maintenance and Other costs – Sunvi Ahsan

“There’s a really different crowd of buyers coming through,” Tassell says. “Low rates are a big part of it. They can buy a property that’s only returning 5% but it’s not killing them to do that and they’re getting good growth. Auckland might be at the top of the market but in Christchurch, Wellington and Tauranga, for instance, we still see growth coming.”

These interest rates make borrowing appealing and add to the financial incentives that have been encouraging investors since 2009, says Tony Alexander, chief economist at

BNZ: “The incentive is to buy now. That’s still the case this year and maybe next year. But beyond that it’s highly risky territory – it will change, but we’re not there yet.”

Strategy: increase cashflow

Whether borrowing to buy or renegotiating current loans, there’s plenty to think about. Lenders are offering not only bargain-basement rates, but also cash incentives, facility-fee-free revolving credit and contributions towards legal costs and break fees for borrowers switching banks (see sidebar).

Property shortages mean other investors are using debt to develop their existing properties. With a lack of supply still propping up the Auckland market, many investors are extending, says Church, while Gosse has seen investors adding minor dwellings to increase cashflow. Several investors (see below) are using the low rates to make trading more cost-effective, using the cashflow generated by buying, renovating and reselling to fund debt repayment on their buy-and-hold portfolios.

Strategy: Build Equity

For the more conservative or established investor, these rates are the chance to pay down more debt, move to principal-and-interest payments and generally increase equity.

“By repaying principal as fast as possible, there’s a buffer I have created – and those who have created a buffer are in a better position,” Ajay Kumar says. Kumar, the founder of Global Financial Services, forecasts to advise $1 billion in lending this year.

“Make sure you are on a firm footing if that rate goes up in the future. Anything that goes up one day has to go down; there’s nothing in the universe that always goes up and the property market is no exception.”

That long-term perspective is one that strikes a chord with other experienced investors. Gearing up right now means you may not be in a position to buy when prices flatten or drop, says Sunvi Ahsan, who has stopped buying for now and plans to hold his long-term portfolio steady, while trading for cashflow.

“Pay down as much debt as you can because if it does collapse it’s not just higher interest rates you have to cover, it’s also maintenance and other costs,” Ahsan says. “I’m paying off as much as I can, I only pay principal and interest, and I’m targeting one house at a time. So far I’ve paid two off.”

Strategy: Lock in for Longer

Wellington-based investor and mentor Peter Ambrose, now of iFindProperty, is happy to pay slightly more to lock in these low rates for longer. Whenever a loan comes up for renewal he is fixing for five years at the lowest possible rate, rather than using his previous strategy of dollar-cost averaging.

“It’s like Christmas and my birthday at once – I’m long-term, buyand- hold, so I do predominantly interest-only and pay off debt via trading,” Ambrose says. “That means I can control my cashflow.”

Would he still be trading if the interest rates were higher? Ambrose says it’s just another number. “Do the numbers work? If the deal works, I’ll do it, regardless of interest rates. Nothing in my strategy has changed.”

Although you will pay a little more for a three-, four- or five-year fixed rate, if those numbers work for your properties they reduce your risk, cement your outgoings and give you certainty – all valuable commodities in an uncertain economic climate.

“Why wouldn’t you fix for three or four years if you can get below 5%? If you’re in there for the long game that’s the smart thing to do,” Adrienne Church, general manager at specialist lender Resimac Home Loans, says. “Unfortunately I think a lot of people are in it for the short game, thinking they can make a quick buck. That’s possibly a bit risky, but with net migration I think that risk is counterbalanced.”

Plan Ahead: Reserve Bank Move

Risky strategies are a reflection of the broad outlook on both the general property market and the official cash rate (OCR): not much change. Property values are likely to rise and interest rates fall or stay steady for this year at least. While a steady outlook might traditionally have reflected a calm economy, at the moment the outlook is being held in place by a range of economic factors pulling it in all different directions at once. As more than one commentator points out, one global event could be enough to cause massive changes in the world economy, which would affect New Zealand investors almost overnight (“Look at Trump for God’s sake,” Ambrose says, “What are we in for?”)

The Reserve Bank’s favourite blunt instrument – the OCR can no longer be wielded in order to achieve the outcomes it wants: higher inflation, a cheaper New Zealand dollar and more affordable housing. Right now we’re seeing rampant asset price inflation and no general inflation, says Cameron Bagrie, chief economist at ANZ, who feels there has been “a structural shift in the evolution of inflation”. The Reserve Bank is keeping a close eye on the property market, particularly in Auckland and particularly on investors.

Interest-only loans are flying out the door at a particularly rapid pace, says Bagrie. Half of all loans to investors are interest-only, while 30% of owner-occupiers are using interest-only loans to buy a home. That’s an area the Reserve Bank could potentially target in the future, he says, though he admits, “That’s an off-the-wall suggestion… It’s outside their mandate but anything’s possible.”

Eyeing Other Tools

The most likely first step for the Reserve Bank is further increases in loan-to-value ratio (LVR) restrictions for investors, says Alexander, with the potential for minimum deposits to go as high as 50% or even 70%. But, like Bagrie, he believes the Reserve Bank will be considering tools we haven’t seen before in the New Zealand market.

“People always underestimate the Reserve Bank,” Alexander says. “Look at interest rates in the past: it would raise them to whatever the pain point was, up to floating at 10.5% or 11%. They can’t use interest rates this time around, so they’ll find that pain point using other instruments. LAQCs, depreciation, LVRs, Brightline testing – these have all had not much impact or the impact has only lasted for a short time. I’ll be surprised if they’re not giving serious thought to loan to income ratios.” Just after we spoke the Reserve Bank confirmed this, though adding this tool wasn’t in a “state of readiness” just yet.

Debt-to-income ratios were introduced in the UK in 2014; lenders are not permitted to lend more than 15% of new residential mortgages at loan-to-income ratios above a multiple of 4.5. With Kiwi household incomes at an average of $84,200 (Ministry for Social Development, 2014), a multiple of 4.5 is a loan of just under $400,000, which doesn’t buy you a lot of house in many regions. It seems this tool, if it included first time buyers, would hit them very hard, especially in Auckland.

Could the Reserve Bank restrict this to investors only? How the banks would calculate investor income from rents remains to be seen. Whatever happens in this environment of uncertainty and low rates, the Reserve Bank is effectively putting investors on warning. If you plan to increase your borrowing you might like to consider putting plans in place sooner rather than later. As Alexander puts it: “For now I think it’s fine, but as each month goes by the risk of the Reserve Bank saying, ‘Sod this’ grows.”

For Break Fees Big Bucks

Are you still on older fixed terms at rates above 5%? If you haven’t already done your calculations on break fees, now’s the time to call your broker. There are certain misconceptions about break fees that swirl around in the marketplace: that break fees are almost always extremely expensive; that if you add them to a loan you’ll always pay more in the end; that switching banks costs so much it’s never worth it. Those ideas serve your lender well; after all, while you’re on your fixed-term loan you’re a guaranteed source of income. Once you break it, you’re a free agent and your bank would rather you didn’t do that.

This lending environment, however, is cutthroat for the banks. Competitive lenders are paying startlingly high contributions to help borrowers cover their break fees – which are often lower than you might expect.

Trending Numbers

Even added to the cost of your loan they can work out to be much cheaper – and don’t be misled by online break fee calculators, because their numbers tend to overestimate break fees massively.

“Some of the banks are paying outrageous break costs,” Church says. “I’ve heard of $15,000 in break fees being covered, plus incentives and cash.”

Break fees themselves, as well as what kind of deal your existing or new lender will offer you, depends heavily on your circumstances, says David Boyle, general manager investor education at the Commission for Financial Capability. Each bank will assess it on a case-by-case basis, but the more debt you’ve got, the more enthusiastic a bank will be about taking on your loans. (Banks don’t like paying break fees on their own loans, but you should always give your existing lender the chance to match a competitor’s offer.)

Take A Holiday

Cash incentives are a great way to kick-start principal repayments. It might be tempting to take a holiday, but before you do that, use a mortgage calculator to work out what impact that $5,000 will have over the life of your loan, Boyle suggests. You might still like to take the holiday, because it’s important to enjoy the journey, he says, but make those decisions with your eyes open and having done your research.

“It can be a challenge to switch. You’ve got to be quite motivated, looking at all the options and talking with your lender now,” Boyle says.

“But it’s a good investment of your time. In the long term, every extra $1,000 saved goes toward more fun in retirement.”


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