The biggest winners and losers when interest rates drop

No question that the winners when interest rates drops are homeowners and borrowers.

Smart borrowers are keeping up mortgage repayments at the old levels to pay down the principal faster, particularly if they can break old contracts at favourable rates to switch to the lower rates.

Borrowers who can re-finance without break fees – movers, for example, or downsizers – will do even better. Investors who finance rental properties will see better yields, as rents have crept up, not down in the past year.

Wise borrowers

However, cheap money is not just being thrown at borrowers. Owner of Mortgage Lab, Rupert Gough, says that banks are still calculating stress tests (that is, figuring how comfortably you can meet repayments) based on interest rates of 8 percent, not the current rates.

He also says that they are also applying tougher lending criteria, looking harder at borrower’s character, even getting tougher on things like sliding into overdraft.

Tom Hartmann personal finance editor for the Commission for Financial Capability’s says the organisations sorted.org.nz tool is helpful way to stress test your savings or investment strategy. The model allows savers or borrowers to see the implications of changes like interest rates going up on repayments or the family budget.

And, yes, borrowers are the winners, he says. But only if they use the lower interest rates to pay down more of the principal of their mortgage, faster, rather than reducing the repayment rate and cutting their time (and interest payments) on a mortgage. Hartmann also warns against using the cheaper finance costs to add to the mortgage to buy, say, a new car or holiday.

And some economists warn that cycles of falling interest rates eventually cause rising asset prices (including property prices) that boost economic growth. It’s happened before but this time there’s no inflation and economists anticipate ever-increasing household debt levels – which will eventually drive interest rates back up.

Savers getting little or no interest on their nest eggs are the well document losers in this cycle. But there are surprising victims. Earning interest on savings was an easy and low risk way to earn enough income in a high interest environment to supplement a pension or fixed income. But in the low interest world, that’s not going to pay the bills.

The unexpected losers: scam victims

That’s when savers turn to more risky strategies, exposing them to scams that wipe out their savings and even lose their homes, says Tom Hartmann personal finance editor and head of the Commission for Financial Capability’s fraud education team.

“People are more vulnerable to scams,” he says. “Those who traditionally lived off their nest eggs will now not have much to live off, they’ll either dip into the nest egg or dial up the risk in order to make more.”

And many of those ‘alternative investments’ people go for, will be complete frauds. CFFC’s own reporting of scams found that $33 million was lost overseas – and that’s just people who’ve reported (most don’t, says Hartmann because they’re embarrassed).

“So much can be faked these days, entire bank websites, investment houses, even entire government agencies,” he says, citing a recent case where neither the UK government authority that purported to register an investment, nor the investment house, actually existed.

Hartmann points out that the losers are not just the immediate victims, but the local economy – businesses that didn’t see that $33 million spent here – as well as indirect costs, such as to the local health system from treating stressed or ill victims.

Hartmann says that young first home buyers are less likely to lose interest on their savings as most are parking the funds in KiwiSaver, which is actively investing on their behalf.

“But some people may dial up their risk to meet their savings goal. We encourage people to use the sorted.org.nz calculators to take into account the new low interest environment to see if that may delay them reaching their [savings] goals.”

Winning ways with KiwiSaver

Richard Klipin Chief Executive Officer Financial Services Council of New Zealand, whose members include fund managers, KiwiSaver and professional providers to the sector, says that the growth in KiwiSaver assets by $1.26bn, 16.5% over the year to March, is still helping to create long term wealth for the 2.85 million Kiwis who are in the system.

“Winners could be people who borrow to invest in assets. But high return brings high risks,” Klipin says. “Investors need to be really cautious, get advice and have a clear strategy.

“The market dynamics are always changing – today’s news is different news from five months ago, things are always in change. So get a clear game plan, don’t follow the fads.”

Klipin points out that KiwiSaver funds are invested in diversified portfolios, a mix of cash and fixed interest, local and international, infrastructure and other products and services.

CFFC’s research shows KiwiSaver returns have big differences in earnings depending on the fund chosen. From 2013-2018, earning potential almost doubled between conservative funds compared to growth funds: average returns (before fees and after tax) were 4.54 percent for conservative, 6.54 percent for balanced compared to 8.38 percent for growth funds.

But there’s a catch: only first home buyers and people over 65 can access their KiwiSaver funds. So savers who want to tap into their funds before that will have to look elsewhere.

Klipin says the perennial advice still stands: having a clear plan of whether you want your money to be earning an income out of investments or grow the asset base and being clear on what your appetite for risk is. Getting advice from experts also helps retain a long-term view, he says. That affects what class of assets – property, shares, something else – you should invest in.

“For example, buying property for a quick return in 12 months is not likely now, the returns are more likely three to seven years away.”

Like Klipin, Hartmann points out that while the environment has changed, the principles for managing our finance stay the same: making a plan, taking on only the amount of risk that you are comfortable with and managing debt so that you do not over-extend finances.

With talk of interest rates dipping below zero (Reserve Bank governor Adrian Orr saying “zero is no magic number”) and the economy slowing, now, more than ever, savers and investors need to do their homework and take advice from trusted sources to make it through diversifying their investments.