Mortgages

The Interest Rate Illusion

We are constantly lured by advertisements promoting sales of discounted products; so it is natural we tend to seek the best price for anything we purchase. What’s more, there is a tendency to equate a cheaper price to the best option. Naturally, we carry this expectation with us when we go shopping for a home loan.

This is a mistake if you want to grow your wealth. Interest rates are an illusion. Rather than seeing rates as a cost that has to be reduced, see them for what they are: a side effect of getting as much as money as you can so you can create wealth for you and your family. After all, it is the amount of money you have invested, not the interest rate you get, that allows you the opportunity to build your wealth.

Purchasing loans on interest rate alone actually plays to the bank. The bank makes money by lending at the lowest possible risk, so it’s best to know that they offer you an interest rate which they can get away with to achieve this. They advertise primarily on a rate to attract new customers. They manage risk by setting credit guidelines, which can be manipulated to attract the right clients and to manage their exposure to the various markets. For example, if the lender feels risk in their exposure, a simple change in LVR (Loan Value Ratio) can drive a result. Banks can alter servicing calculators, increase living expenses, increase the weighting for existing debt and reclassify security types. These measures along with a myriad of others have a direct influence on your ability to borrow.

By dictating what criteria customers must follow, banks limit our ability to invest using borrowed monies. Understanding bank limitation we can focus on what’s important, which really is the ability to obtain the money to buy and avoid placing emphasis on securing the lowest interest rate. While the interest rate may be important for a First Home Buyer, the smart investor needs a different focus.

An investor not only tries to maximise the amount they can borrow, but they also structure the loan so that they create a buffer for emergencies and a reserve for future opportunities. The idea is to protect oneself from sudden unexpected expenses as well as being ready to take advantage of any investment opportunities that may arise. Borrowed money is not for holidays, cars, or other personal expenses. It is directed solely creating wealth a larger and more robust portfolio which can eventually replace the need to work for money.

The more money in reserves, the safer investing becomes. The more reserves you have for an emergency, the easier one can sleep at night. The faster the renovation the less time without a tenant. The more money, the better a position to negotiate a purchase for example. Control is in the hands of the capital holder — not the bank — the lowest interest rate in the world is useless if one can’t get the amount of money needed to buy a property.

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