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Is a Low Interest Personal Loan in Australia a Good Thing or Bad Thing?

By February 27, 2020 No Comments

People take out loans for many different reasons, some need a little extra help to afford things like a new car or their first home. Other people apply for loans so they can pay for big events in their life, such as a wedding, while some people apply for loans for emergencies like medical bills and similar emergency expenses. Regardless of what the loan is for, you can already tell how useful loans are during times of need. Just as there are many different reasons for taking out loans, there are also various types of loans that you can choose from. Now, is a low interest personal loan in Australia a good option for you?

The Importance of Interest Rates

The Reserve Bank of Australia (RBA) has reduced the cash rate from 1.5% to 1.0%. As a borrower, you might think that this benefits you as this means you will have lower repayments for your loans. But, is this really a good thing for you?

First of all, you should know that interest rates are one of the main tools that the RBA uses to manage and improve the health of Australia’s economy. For example, rate cuts such as the one mentioned previously can give cash back to anyone with a variable rate home loan. If these individuals opt to spend the money instead of saving it, then this will contribute to a valuable boost to the economy. 

This rate cut does not only affect homeowners with mortgages, but it also affects businesses who borrow in order to grow. The lower rate can encourage businesses to apply for loans and level up their company.

The RBA is keen on encouraging people to spend to support the growth and expansion of the economy. 

The Australian Economy

The unemployment rate in Australia is quite low. It remains steady at a low of 5.2%. On top of that, the labour force participation rate increased by 0.1 to 66.1%. So why does it matter that the participation rate is rising? This is an important detail that says that more and more people are actively looking for work instead of giving up and accepting their fate as an unemployed individual.

There may be some kind of media hype that states that the Australian economy is going backwards, but that is simply not true. In fact, the economy increased by 1.8%, which is at the same level as G7 economies like the UK, US, Germany, France and Canada.

This does not mean that it has been a smooth ride for the Australian economy as the country’s economic growth is lower than it has been. Why is this happening? For one, there is a very low pace of wage growth at a time when inflation is at 1.6%.

What’s happening now is that the RBA expects that households will spend around half their tax savings, which will help improve the economy. This will be triggered by the tax cuts for low and middle-income households. 

The Property Market Situation

Currently, household spending has been lowered due to the cooling of the property market in both Sydney and Melbourne. This change is due to the fact that homeowners are aware that they have lost part of their home equity.

However, there were some improvements around June and July last year. Values in Sydney and Melbourne have risen 18.4% and 23.5%, respectively, over the previous five years. At the end of the day, long term homeowners are still in front—financially—by a fair margin.

Now, due to the low interest rates on home loans and personal loans in Australia on top of more affordable property values, first home buyers are more encouraged to head back into the market.

Overseas Threat to the Australian Economy

A real threat to the Australian economy comes from overseas. There is an ongoing trade dispute between the US and China that has been occurring for two years. Although the direct impact of tariffs is not significant, the issue is taking its toll on business confidence.

Due to trade issues, businesses all over the world are being more conservative in the sense that they are implementing a wait-and-see approach before they invest. This approach significantly affects global supply chains.

This may be problematic for some. However, Australia is not really deeply involved in the global supply chain. In fact, due to the stimulus directed to China’s economy, the demand for Australian coal and iron ore is boosted. 

What is an Inverted Bond Yield?

You may hear this term on the news, but what does it all mean? There is so much information being thrown around that it can get confusing. Simply put, the inverted bond yield refers to a scenario where long term bond yields have fallen below short term yields, and that’s not usually the case.

In the past when bond yields have inverted, it is seen as a sign of recession. But keep in mind that this is not always the case. Take note that inverted bond yields are not an accurate and reliable indicator of a slowdown. Although there are no clear signs pointing to a recession, this phenomenon does seem like a risk to the global economy. When this happens, it is best to take a planned approach, but not to completely shy away from spending decisions.

Low Interest Home Loans and Personal Loans Benefits

When the interest rates of loans are exceptionally low and lenders are eager to have a new business, there are many opportunities for borrowers to set their plans in life into motion. A strong economy gets people wishing for low interest rates because this makes it less expensive to borrow money. 

Normally, the Federal Reserve sets low interest rates in attempts to push the economy out of recession. As previously discussed, lower rates encourage both businesses and consumers to borrow and spend money. Since loans put money into circulation, it raises the money supply, which in turn supports economic recovery. 

Disadvantages of Low Interest Loans

In some cases, people use their money to pay their debts and invest in goods when they are unable to earn an attractive interest income on their money in the bank. They may also invest in services or assets such as houses or stocks. This means that banks will be losing deposits.

Insurance companies are also affected by this since they rely on a certain interest-based return on the money they receive in premiums to support their coverage liabilities. Lower rates may mean higher insurance premiums. Low interest rates can also negatively affect people who live off the interest income from their savings. These people would have to cut back their spending. So, if a large group of people such as a whole generation of baby boomer retirees lessen their spending, then the overall economic activity will slow down. 

Here are the disadvantages of lower interest rates:

1. Applying for loans or borrowing money is more difficult.

The increase of the interest rates and removing money from the monetary system results in an economic contraction. So, to boost the growth of the economy to push it out of a recession, the aim would be to lower interest rates a few points to encourage small business and consumer borrowing. 

As you know, banks have a large sum of money in their deposit accounts, which are attracted by high interest rates. Needless to say, banks would be eager to lend to you. The issue comes in when interest rates are abnormally low; banks do not have a high deposit base and the income from loans doesn’t encourage taking risks. In this case, lenders and banks will only want to loan to borrowers with high credit ratings and substantial assets.  

2. It is a sign of deflation.

Liquidity traps are everywhere when the interest rates are low. This happens when an interest rate is so low that it does not serve the normal function of spurring the economy to growth. Instead, what it does is decrease the flow of money to the mainstream economy because it goes into investments in assets that don’t produce employment. Some examples include the stock market and paying down loans. 

In this scenario, the money does not flow through the economic system. This can result in rising unemployment rates. Companies would have to let go of employees with higher salaries and hire employees for a lower salary. Lower wages mean that people would have a hard time buying things, which can result in a decrease in the prices of goods and services. Then, more people will be let go due to the company’s inability to afford their salaries. It is a cycle that needs to stop before the economy continues to spiral downwards.

3. This can possibly result in inflation later.

In normal circumstances, low interest rates encourage people to loan money and as you know, loans add new money to the money supply. So in the case of a credit crisis, lowering rates can inject money back into the system that can trigger economic activity.

However, this may result in a large money supply and a liquidity trap. Too much money in the system results in inflation because it follows a fixed amount of goods and services which increases their prices. 

Conclusion

Low interest personal loans in Australia may sound like a deal at first, but make sure that you understand what may be the underlying reason for beautifully packaged deals. It would be best for you to make informed decisions based on thorough research and facts. This will ensure that you do not end up with more than you bargained for.

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