Low interest rates are bad economic policy by Central Banks trying to stimulate economies with low growth.
Why?
Lowering interest rates does not fix the real underlying problems in an economy.
There are so many other factors driving the operation of an economy. Central banks and governments fail to tackle the real problems in the economy. They prefer to lower rates because it’s easy to change the cost of money.
All it really does is encourage people to borrow too much money and live beyond their income means. Young people borrow too much money and buy everything they want but not what they need. They get themselves trapped in debt at a young age.
Older people who have worked hard and saved a nest egg are penalized with low investment returns. These people are forced into buying property or stocks to get a better return on their money. That unnecessarily increases the investment risk and causes people to lose capital or lock up their capital in property or stocks.
Why are Low Interest Rates Bad?
If an economy has low growth or is heading for a recession why not lower official interest rates to make money cheaper to borrow.
Low home loan rates result in home owners paying less interest on their home mortgages.
Home owners have excess income available to spend or save.
Also, home owners can borrow more money against their home and fund a more extravagant lifestyle. Now that boat, camper, new furniture or overseas holiday is easily within reach.
When people spend money it generates increased economic activity.
Low interest rates encourage home buyers to borrow more money and purchase a more expensive home than they would otherwise.
Renters maybe able to afford to purchase their own home and build their capital rather than expense their earnings on rent.
So lower interest rates seem to be very appealing. Everybody can afford to have more!
Please read Why Home Loan Interest Rates Are Low
Low Interest Rates Are Political
Governments around the world have been successful at convincing people to vote them into office because they have lowered or kept low interest rates.
Voters seem to be brainwashed that low home loan interest rates are good for them!
Afterall, voters can borrow more money and have more lifestyle choices.
Please read Why Houses Are Expensive
High Personal Debt Level
The level of personal debt has been steadily increasing for decades and now it’s at an all-time high. Many economists are worried that there could be an economic collapse if the level of debt increase any more.
The problem with lowering interest rates is that people borrow more money when they already have a mountain of debt. And banks encourage people to borrow more because the banks have to keep lending money to earn profits.
Banks don’t really care if some people borrow too much money and get themselves into financial stress. If a borrower defaults on a loan the bank takes possession of the property and sells it to recover the proceeds of the loan. Mortgage default sales occur in the normal course of business for banks.
The Effect of Low Interest Rates
Low interest rates cause investors to move their money overseas into other currencies that pay higher rates. The outflow of money causes the foreign exchange rate to reduce making imported goods more expensive.
Low interest rates make borrowing more money easier especially when secured with a home mortgage. People borrow money and spend it on property, motor vehicles, home furniture and appliances, vacations and more.
The increased domestic spending generates increased economic activity leading to positive economic growth. However, the increased demand for consumer goods causes cost push inflation. The economy booms and prices increase. Central banks raise the official rate to dampen the increased economic activity.
Raising interest rates hurts borrowers as they have to pay more interest on their loans. Some borrowers cannot afford the extra interest and are forced into selling assets to repay debt.
Please read How to Get Your First Investment Property
The Effect of High Interest Rates
Higher interest rates cause overseas investors to move their money into the country to earn a higher interest rates on their investments. The inflow of money causes the foreign exchange rate to increase making imported goods less expensive.
High interest rates make borrowing money more costly and people spend less on property, motor vehicles, home furniture and appliances, vacations and other consumer goods.
The decreased domestic spending generates decreased economic activity leading to low economic growth or even negative growth. However, the decreased demand for consumer goods causes prices to fall. The economy slows and prices may decrease. Central banks lower the official rate to stimulate economic activity.
Investors earn more interest on investments with no more risk.
Very high home loan rates can cause inflation. The cost of capital increases and this drives up the price of capital assets such as real estate.
Higher Interest Rates & Lower Property Prices
Lowering home loan rates only causes property prices to rise. Sure it’s cheaper to borrow the money but you’ll just pay more for the real estate. Overall, home buyers lose because cheap money doesn’t last forever. The mortgage rates increase and borrowers pay more for the loan.
The banks always win because they earn a margin on lending money. The banks don’t care if interest rates are low, medium or high. Banks source funds and add an interest margin before lending the money to customers.
It’s better to have higher home loan rates and lower property prices.
Everybody wins when property prices are stable and home loan rates are higher.
There are lower entry barriers for first home buyers. First home buyers can actually save a reasonable deposit and enter the market.
Also lower barriers for people moving up to their second or third home. And it’s easier to buy an investment property.
Conclusion
In an economy with normal economic conditions the interest rate will fall between a normal operating range of say 2% to 6%. Home loan rates should be 4% to 8% in a normal economy.
Home buyers want stable economic conditions and stable house prices not booms and busts.
Mortgage rates are just like everything else in the world.
Too high or too low is not good.
There is a happy medium.