While all long-term investors know that interest rates are broadly cyclical, Australia’s official cash rate has now reached historic lows. It’s not great news for cash-focused savers who will struggle to get more than a 3.00% return on their cash investments now (you can compare current term deposit interest rates here). On the other hand, with the latest cut in official cash rate taking us to just 1.75%, it’s a great opportunity for those who have debt to really get ahead on their personal wealth accumulation.
So here are five ways to put the recent cash rate cuts to good use.
Pay off personal debt
It really goes without saying that non-deductible debt such as a home mortgage or consumer debt should be paid off as soon as possible – but let’s put some savings figures to that.
Non-deductible debt is debt that doesn’t have any tax benefits. That includes your home loan, personal loans and credit cards. It doesn’t include margin loans, investment property loans or any other loans that are used for income-producing activities and on which the interest is tax-deductible.
While the official cash rate now is just 1.75%, and the average package variable home loan advertised rate is just 4.38% (a rate that will decrease in the coming weeks), the average variable rate on a personal loan is between 13% – 14% and the average credit card interest rate is 17% – a price that hasn’t changed since the official cash rate started falling back in late 2011. So it makes sense to put any home loan repayment savings towards this high interest rate debt and to get rid of it.
Here’s an example of how much you could save in credit card interest by increasing your repayments:
|Repayment $200 per month||Repayment $500 per month|
|Debt of $8,000||Will take 5 years & 3 months to pay off, at a total cost of $12,435||Will take 1 year & 7 months to pay off at a total cost of $9,130|
|Interest rate of 19%|
Paying extra onto your home loan can also save you significant money and free up your cashflow sooner. Based on a home loan over 25 years at an interest rate of 5%, an extra $300 per month in repayments could potentially see your home loan paid off in the following timeframe:
|Loan size||Time to pay off|
|$300,000||18 years, 10 months|
|$400,000||20 years, 1 months|
|$500,000||20 years, 11 months|
|$600,000||21 years, 5 months|
Become positively geared
Tax deductions on investment loans are okay – but a positive cashflow isn’t bad either! As investors know, property can either be positively geared, where the cost of holding the investment is less than the income you receive from it, or can be negatively geared, meaning that the cost of holding the investment is greater than the income.
It is common for property investments to be negatively geared in the early years and Australian Taxation Office (ATO) statistics indicate that approximately two-thirds of property investors make an income loss on their investments.
That doesn’t mean that a loss is always the ideal outcome though. With the majority of taxpayers being on a marginal tax rate of 32.5% plus Medicare levy, the fact is that for $1,000 of outlay, many investors will only receive $325 back. Even investors on the top marginal tax rate of 45% will receive less than half their outlay back from the ATO. Over time, capital growth should hopefully compensate for that cost but a low interest rate environment gives investors the opportunity to pay down their loan as quickly as possible and hence minimize their out of pocket expense.
Get advice on superannuation contributions
While you cannot access your retirement nest egg until you reach your preservation age there is no question that superannuation is a tax-favoured investment vehicle. As such, taking advantage of lower loan repayments and diverting some excess funds into your superannuation can be a terrific investment strategy for some investors.
Concessional contributions are taxed at a rate of 15% when paid into your super fund and therefore represent a significant taxation discount for anyone earning over $37,000. Do be aware, however, that if you make concessional contributions that are in excess of the $30,000 allowed, the excess amounts will be taxed at a total of 46.5%.
You should also seek personal financial advice before deciding whether additional superannuation contributions are a good idea.
Improving your property
Lower interest rates and mortgage repayments could also pose an ideal opportunity to divert the excess cash towards property repairs or improvements. If it?s your own home it obviously makes it nicer to live in and if it?s an investment property it can make it more desirable in the eyes of a prospective tenant. A fresh coat of paint, some new carpet or beautifully-polished floorboards could make a world of difference. Some new garden beds, a gleaming kitchen – or a gleaming new bathroom – could enable you to boost your rent.
The table below shows a selection of home loans available on the Canstar database for property investors located in Victoria with direct links to the providers website, for a loan amount of $500,000 with an LVR of 80% (20% deposit) sorted by our star ratings (highest-lowest).
According to Roy Morgan Research, 30.5% of us made minor home repairs in the year to June 2015 – and with home loan rates falling, those who have equity in their home could be in a good position to renovate cost-effectively. Renovating, as opposed to selling and buying elsewhere, also saves on stamp duty!
Of course, if spending money on your home or investment property is on the cards, ensure that you calculate your costs precisely to prevent your expenses from blowing out. And with regards to investment properties, get professional advice to ensure that you understand what expenditure can be claimed as an expense for tax purposes (generally repairs and maintenance) and what is a capital expenditure (generally classed as improvements). Your capital expenditure may be able to be depreciated over its effective life.
Invest in yourself
If you have a little extra cash in your pocket, now could be a good time to do that further study that you have always intended to complete.
There is plenty of research to indicate that the more qualified a worker is, the higher their average lifetime earnings. So while a university course may not be a tax deduction up front, it could nevertheless be a great long-term investment.
As with everything financial, the right course of action will depend on your personal circumstances, so it?s important to seek professional advice before jumping in to any long-term commitment. But whether your goal is to expand your assets, improve your savings or just to sight tight for a while, there are certainly plenty of opportunities to grow your long-term wealth in a low interest rate environment.