Rising interest rates are coming.
Ever since the reserve bank of NZ announced that inflation is higher than expected, there is a lot of interest surrounding the topic of interest. Remember how interest rates are an economic tool that central banks can use to control inflation? There has been a lot of discussion of how the reserve bank of NZ is going to tackle this situation. Many observers suggest that they will raise the Official Cash Rate (OCR) to bump up average interest levels around the country.
For now, it looks like the Reserve Bank will look at tightening lending standards to prevent regular folk like us from over-borrowing. This will protect many middle class earners from the sting of a hike in interest rates. But it will also unfortunately price many younger families and first home buyers out of the market. All of this signals that an interest rate hike is on the horizon. It is, to paraphrase Thanos, INEVITABLE.
Will I be hurt by rising interest rates?
That depends on how much loans/mortgages you have and who you have it with.
If you have borrowed money from a friend, then an OCR hike won’t affect you. In fact, your relationship with your friend should not be affected by OCRs. If it is, you need to reconsider your friendship.
If you have borrowed money from a small-time/payday money lender, an OCR hike won’t affect you either. They will still charge you the same stupidly high interest rates as before.
If you have any credit card interest outstanding, an OCR hike shouldn’t affect you either. You should still focus on paying off that credit card debt!
If you have any other types of borrowings with the bank, (business loan, overdraft, or mortgages) you are going to feel the pinch from a rise in OCR.
What should I do about the rising interest rates?
Good question.
If you recently took a mortgage to take advantage of the historically low interest rates then you must know that low interest rates were not going to last forever. This is something your mortgage broker/loan officer should have discussed with you when you first took the loan. So the first thing you should do is to setup a meeting with your mortgage broker/loan officer and ask them the following questions:
- How much will my weekly repayments increase by?
- Can I restructure my mortgage to reduce my weekly repayments?
I’m no mortgage expert – but I know a few things about cash flow. The idea is that you want to be forewarned of the increase in your weekly/fortnightly mortgage repayments. This can be an increase of anywhere between $100 a week to $500 a week depending on how much you have borrowed and how high the OCR hike will be. Your mortgage broker won’t have a definite figure, but they should be able to give you a reasonably accurate estimate.
You should also have a discussion about loan/mortgage restructuring to see if you can reduce weekly repayments to a level you can afford. Note that this sometimes may mean extending the loan duration – so you will need to consider how your mortgage fits in with your financial goals.
If you are locked into a fixed interest rate for a number of years, you don’t have to worry about any interest rate hikes until that fixed term ends. After which, you will want to talk to your mortgage broker/loan officer about your options.
Will rising interest rates affect my business?
It depends.
If you have heavily borrowed from banks to finance your business, then there could be an interest hike, unless you are on a fixed rate. The magnitude of the hike would be smaller than that on mortgages, but it will still be there. If that is the case, you will need to manage the levels of debt in your business more carefully. You should:
First: Identify your debts and record their outstanding values
If you have an awesome accountant working with you from day one, you will have a record of all the outstanding loan balances you have.
If you don’t have an accountant (or they’ve done a pretty poor job). You will need to access your loan accounts and review how much you have left to pay. Once you figure out what your debts are, you can move onto the next step:
Second: Create a plan to repay your loans
You may want to consider increasing the amount of repayments you make to push the balance down faster. Before you do this, check with your loan officer that you are allowed to do this. Some loans have a fixed repayment schedule and you can get penalised for paying off your debts early (yes, I know it sounds stupid, but that’s how banks make money). If you can make early repayments, you will need to review your business’ cash flow.
Sit down with your accountant and have a think about:
- How much cash your business generates a month
- How much cash you take out of the business every month (if you have drawings)
- What are your business’ main cash out flows
From there you can develop strategies to reduce expenses or reduce the amount that you personally take out of the business. This allows you to create more funds available to pay off your loans.
Note that if you have borrowed from the Small Business Cash Flow scheme, your interest free period should remain unaffected. I don’t expect the fixed interest rate to change either, but if you can repay the loan within the interest free period you should. This way you can avoid any nasty surprises if the Government decides to up the interest rate on that to better reflect the increased OCR.
Should I pass on the increased interest costs onto my customers?
I’m not a big fan of passing on the cost to customers as a knee-jerk reaction to rising costs.
Rising costs should not be the primary driver of your pricing strategy. Your pricing strategy should look at factors such as market rates, competitor activity and what your customer base is happy to pay.
That being said, an overall increase in interest rates will have a knock-on effect that should reduce consumer spending. If anything, you might find that customers (many of whom have got mortgages to service) will look at cutting their personal spending. You may even find yourself in a position where you have to reduce your prices to attract/retain customers. In other words, be prepared for a tight period should the OCR be hiked up significantly.
Wow, that all sounds really scary.
No, it shouldn’t be scary. Interest rates will have to go up at some point. Otherwise, we will have to deal with over-inflation.
There are is a lot of debate around the topic though. Some economic commentators have pointed out (quite rightly) that COVID-19 is still running rampant across the entire world and the global economy is still impacted by this. This means that interest rates should be kept low so that we in NZ can enjoy our current levels of growth and be better prepared when the global recession hits us.
The other argument is that higher interest rates will make it harder for middle-income earners to service their loans. It can also price out first-home buyers out of the market (like me!).
As much as I personally don’t want anything to change, from an economic and financial point of view, our current low interest rate regime is unsustainable. Change is coming, interest rates will rise in the near future. The best we can do is to be prepared!
And Stay Positive!