What should I do when interest rates cuts occur?

​We’ve all heard recently in the media about the Reserve Bank of Australia (RBA) cutting interest rates (IR), however what does this actually mean for your mortgage? How can you maximise this opportunity? And how can you retire in financial comfort?

There’s no need to overcomplicate IR cuts, so let’s keep things simple. If the RBA cut interest rates by 1.00%, and your mortgage is $300k, you will save $3,000 per year in interest…Ok, so this isn’t too bad, better in your pocket than the banks, however what if you could do more? What if you could pay your home off sooner, create an investment portfolio or simply retire with over $600,000? Would you look at this opportunity a little more seriously? I’m sure by now, you are saying YES, so let’s take a look…

3 simple opportunities to make the most from interest rate cuts

Opportunity 1        Make the same repayments

If the minimum repayment on a 300k mortgage is $20,436 per annum over 30 years, based on a 5.5% interest rate (IR)…Imagine what happens when the interest rate drops by 1% to 4.5% and you continue to make the same repayments. You would pay your mortgage off in only 24.1years (as opposed to 30 years) and would save a whopping $121,568 in total interest repayments over the life of the loan.

Result:                   Mortgage paid off 5.9 years earlier + Save $121,568 in interest


Opportunity 2         Invest (it’s not that scary)

If you were to invest the $3,000 IR savings each year into an investment returning 10% per year (assuming tax has already been paid), the investment would be worth $518,000 after 30 years.

Result:                   Investment worth $518,000


Opportunity 3         Salary Sacrifice into Superannuation (it’s easy to set up)
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Home loan repayments are made from after tax dollars, meaning you earn money from your employer, you are taxed, and then you make a house repayment after your pay hits your bank account. On the other hand super salary sacrifice contributions are made from before tax dollars. You earn money from your employer and your super contributions are taken out before tax is calculated. Helping you maximise pretax dollars…No need to pay tax unnecessarily…

Let’s talk figures for a moment, don’t switch off just yet, keep reading, it’s really quite simple…

If your marginal tax rate is 37%, it actually takes $4,762 of pre tax dollars to be left with $3,000 after tax dollars. A quick calculation, $4,762 – 37% income tax = $3,000 after tax dollars.
You are saving $3,000 in mortgage repayments due to the IR cuts, so you could potentially salary sacrifice $4,762 per year into your superannuation fund.

The immediate advantage here is that super contributions tax is only 15% versus 37% of income (in this example). $4,762 per year of salary sacrifice contributions to super, with an investment return of 10% (assuming tax has already been paid), the super fund would be worth $698,000 after 30 years.

Result:                   Super Fund worth $698,000 (how do you see yourself in retirement)

Small changes can make such a difference…When presented with an interest rate cut it is so easy to get into the habit of spending the savings and not putting that money to better use.  $3,000 is only $250 per month, $58 per week or $8.22 per day.  When you consider that spending an additional $8.22 per day is not likely to improve your lifestyle much at all, however looking at an investment portfolio of over $500k or a superannuation fund worth nearly $700k, you can see how a small change can make a big positive difference to your future lifestyle.

Written by Michael Hogue.