Is it worth taking a loan with a higher interest rate?
finance-advice
1 minute read

Is it worth taking a loan with a higher interest rate?

Is it worth taking a loan with a higher interest rate?

by Victor Kumar | July 30, 2018 | 1 minute read

One of the biggest mistakes I see new investors make is being too fixated on interest rates. Plus, they often forget that interest rates are always relative to what is happening economically at that point in time.

July 30, 2018

If we look back at the GFC, for example, interest rates were sitting between 6 and 8 per cent and yields were between 8 and 9 per cent in the mortgage belt areas.

Fast forward 10 years and now interest rates are about five per cent and yields are sitting at about 3 per cent, which is a huge turnaround.

The thing is, the differential between yields and interest rates has always been between one to three percentage points in these mortgage-belt areas. So, the only thing that has really changed is the dollar amount that you’re paying for a property.

Back then, we were paying $180,000 to $200,000 for a unit, but we’re now paying $350,000 in Sydney’s South West. A decade ago, in 2008, we were paying $250,000 to $350,000 for a house but now it’s $600,000.

So, the fundamentals haven’t really changed if we look at these figures apart from the entry cost.

Rate reality

It was only about three or four years ago that if you had a 4.99 per cent interest rate you were doing high-fives. However, now some buyers and investors are saying that an interest rate of 5 per cent is “expensive”.

People have clearly forgotten that the average interest rate has always been around 6 per cent!

The fact is that banks qualify potential borrowers at a much higher rate, meaning that they are factoring in an increase of 1–2 percentage points at some point in time, to ensure people can still service the loan in the future.

Like I said, the problem is that too many people are focused on the interest rate. They’re aiming to achieve the lowest rate from one of the big lenders, which in today’s environment takes the most time.

Generally, in the past, loan approvals could be achieved in about a week from one of the Big Four banks. Today, that timeframe has ballooned out to three weeks because of the additional checks and balances required.

In the meantime, investors are at risk of losing the deal altogether because of the delays in securing finance.

And that’s why savvy investors consider loans with higher interest rates and shorter approval timeframes because they don’t want to miss out on opportunities. Plus, they know that they can always refinance in the future once the property is part of their portfolio.

Rate folly

Chasing a cheaper interest rate when lending conditions are tough means you will be racing to get the loan approved even within 21 days, plus the vendor might opt to not grant you a time extension, if the loan isn’t approved.

Second-tier lenders, on the other hand, are generally not constrained to the same degree and often require less paperwork, which results in a faster processing time.

Of course, the trade-off is a higher interest rate, but we need to keep this in perspective. The rate differential is often just 0.5 to one percentage point higher, which is just $2,000 to $4,000 annually on a $400,000 loan.

Plus, you are usually able to get a loan much faster, which means that you don’t miss out on opportunities.

I regularly use this strategy and within a year, or so, refinance via the same lender or even a new one if they don’t come to the party, to a much cheaper rate. Obviously, I have taken into account exit and entry fees for the loans.

I’ve usually also completed a cosmetic renovation, so I’ve achieved a value uplift which is much greater that the higher interest rate has cost me over that timeframe. The key, of course, is to not get fixated on interest rates, within reason.

What matters in the long run is growing your portfolio when you can and using whichever lender – either big and small – that will enable you to make that happen.

At the end of the day, capital growth over time will always be superior to a short-term period of paying higher interest rates.

If you miss out on deals because you think low interest rates are more important than what they truly are, then your portfolio – and your wealth – will likely suffer in the long run.

About the Blogger

Victor Kumar

Victor Kumar

Nearly 15 years ago Victor and his wife came to Australia from Fiji with just $4,500 in their pockets. They worked hard as radiographers but realised this was not the way to prosperity. Victor embarked on a process of building wealth through property. He has amassed a substantial property portfolio, and is still actively buying and renovating property. His recommendations are based on what works in today’s market, not what used to be effective a year or more ago.

Victor’s experience, finance background, and financial planning qualifications mean he is well equipped to negotiate with banks – helping them find ways to say “Yes”. He has also invested significant time and money in learning from other property investment experts and knows how to make a portfolio work.

Of course, Victor has made a few mistakes along the way but these have made him wiser – and he’ll let you learn from his mistakes so you don’t need to make them. His goal is to help you achieve your financial goals by sharing his extensive knowledge about financial structures and investment property.

Victor is now sought after as a keynote speaker at several property investment seminars and is acknowledged by his peers as an expert in the industry.

http://www.rightpropertygroup.com.au/

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