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Your investment determines your strategy

 

October 2015

 

Split, fixed or variable? How you manage interest rates depends on the assets you invest in.

 

 

 

It’s important for borrowers to adopt an interest-rate protection strategy that suits the type of asset they’re buying and the length of time they plan on holding it.

There isn’t one ideal interest-rate strategy for every borrower. The appropriate strategy depends greatly on the asset they’re buying, why they’re buying it and how long they plan on keeping that investment. It will also depend on the borrower’s ability to tolerate uncertainty and volatility.

A sound interest-rate strategy can potentially help long-term investors and borrowers save money, protect against the risk of rising interest rates and manage their cash flow.

For investors who plan on buying and holding an investment for three to five years or even longer, now may be an opportune time to consider the potential benefits of a fixed rate strategy.

A fixed interest rate strategy can offer protection against interest rate hikes. It also allows borrowers to know exactly what their interest bill will be each month so they can effectively budget and manage their finances during the fixed rate term.

On the other hand, investors who are buying an asset with the view to sell it and realise any capital gains within a short period of time, may consider a variable rate.

Investors who lock themselves into a fixed rate and subsequently make an early repayment of some, or all, of the unpaid balance may be liable for costly break fees. This is a cost incurred by the loan provider based upon the interest rate charged in the wholesale money markets. Early repayment costs can be very large and will vary based upon the money market rates, generally early repayment costs will increase as money market rates decrease. This highlights the importance of understanding how long you may need lending for before making a fixing decision.

 

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Commercial property credit rules

The right interest-rate strategy will also depend on the asset being acquired, which is why it’s crucial for borrowers to understand the credit and lending rules that apply to specific assets before locking in a fixed rate.

When it comes to commercial property, investors can typically only secure a fixed rate for the term of the lease.

Therefore, any interest rate hedging strategy must match the lease term, even if the borrower intends to hold the property beyond the third-party lease and find a new tenant.

For example, an investor who is buying an office with a third-party lease that expires at the end of 2018 can only lock in a fixed term until then, even if they plan to own the property beyond 2018.

This rule doesn’t apply to residential property or other investments.

The right interest-rate strategy will depend greatly on the borrower, the asset they're buying, how long they plan on holding that asset and their objectives. It will also depend on the economic environment, the level of rates in the interest-rate cuclle and the outlook for interest rates, which is why it's important to seek advice from a professional financial adviser.

…investors who are buying an asset with the view to sell it and realise any capital gains within a short period of time, may consider a variable rate. James Dunlop, ANZ Private.

To discuss what this insight could mean for you, talk to your ANZ Private Banker directly, or contact us below.

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