No thanks, Mr Orr, borrowers should hold on to their money

Wednesday, 21 August 2019

OPINION: The message is clear. For the good of the country, the Reserve Bank wants us to spend more.

With the global economy at a tipping point, the stimulus provided by increased spending could help delay or lessen the impact of lower economic growth on our economy.

To encourage us to spend more, the official cash rate has been dropped with the expectation that this will flow on through to lower interest rates offered by banks. The surge in property prices over the last few years has left many homeowners with vastly increased net worth, which can be tapped into with additional borrowing.

Many will be tempted to take out another mortgage at a low rate to buy a new car, book an overseas holiday, or add an extension to the house.

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* The OCR: a tool NZ's most powerful banker uses to get you spending or saving**

Liz Koh: 'A sudden change in income, whether it's due to loss of employment, illness or some other factor causes huge financial stress.'

Existing mortgages, of which the majority are at fixed interest rates, will take some time to roll over to lower rates. When they do, borrowers will have the opportunity to either take advantage of lower mortgage payments or keep their payments at the same level and pay off their mortgage quicker. Lower mortgage payments mean more money to spend on other things.

For first-home buyers, lower interest rates increase affordability and for investors in property and businesses, the benefit is increased net returns, making investment more attractive. But hold on, doesn't this sound too good to be true? There is always a consequence of any financial decision. The Reserve Bank is treading a fine line between saving the country and jeopardising our individual financial futures.

To encourage us to spend more, the Reserve Bank has dropped the official cash rate, with the expectation that this will flow on through to lower interest rates offered by banks.

It's all very well to stimulate borrowing and spending to save the economy, but in so doing, we may be left in a precarious position. The more debt we have, the less financially resilient we are. If the economy continues to spiral downward despite our best efforts to spend like crazy, we will see more redundancies, fewer jobs and more unemployment.

A sudden change in income, whether it's due to loss of employment, illness or some other factor causes huge financial stress. For most people, mortgage payments are the biggest budget expense. Missed payments can lead to mortgagee sales. In turn, this pushes property prices lower and from there the property market can crash like a house of cards, taking with it those individuals and financial institutions who don't have sufficient reserves to be resilient.

Keep in mind here, that the trigger for the global financial crisis of 2008 was a crash in the US property market due to mortgagee sales.

Of course, for those people who are investors rather than borrowers, and who rely on interest for income, low interest rates reduce spending power. To maintain spending at current levels, let alone increase spending, these investors will face the choice of either using up investment capital at a faster rate or investing in assets that have a higher return but more risk. Both of these options increase their financial vulnerability. Good investment strategies are needed to counter the risks involved.

We are heading into a part of the economic cycle where resilience will become the determinant of who succeeds and who fails. Financial resilience comes from having a solid foundation: a low level of debt, the ability to save from income, and access to an emergency fund to cover a temporary loss of earnings. Resilience also means having enough wriggle room to be able to withstand an increase in interest rates again if you are a borrower. This is of importance to first-home buyers taking out a thirty-year mortgage. At some point in that timeframe, interest rates will increase again, pushing up mortgage payments.

For investors, resilience means having a solid investment strategy with an appropriate level of risk. Risk can be managed through diversification and matching investment strategies to investment timeframes.

It's great to be able to take advantage of lower interest rates to increasing spending but the most prudent thing to do is to only borrow for essential spending or investment and to use lower interest payments to pay off debt quicker rather than to spend. While increased spending might be good for the country right now, it's not the best thing for individuals.

Liz Koh is an authorised financial adviser and author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847