What has the Reserve Bank done?

The RBA has lifted the cash rate four times this year, taking it to 4.60%, the highest level in about 15 years. The main drivers have been stubborn inflation and rising energy costs. We don't try to predict where rates go next, and neither should you. What we can do is make sure your plan works whichever way they move.

Is this good news for retirees?

Partly, yes. After years of low returns, cash and term deposits are paying a meaningful income again. At the time of writing, competitive 12-month term deposits are around 5.30% to 5.35% p.a. NAB and ING are offering 5.30% (ING with a $10,000 minimum) and Macquarie 5.35%, all paid at maturity, which means no income arrives until the term ends. For someone who needs steady, predictable income and can't stomach market swings, that is welcome.

So why not put everything in term deposits?

Because the rate is only half the story. We see three catches:

1. Rates don't stay put. When your term deposit matures, the rate on offer may be lower. This is called reinvestment risk, and it can quietly shrink your income.
2. Inflation still bites. A rate of 5.30% looks good until you subtract the rising cost of groceries, insurance and energy. Over a 25 to 30 year retirement, money that doesn't grow loses buying power.
3. It can affect your Age Pension. Centrelink doesn't count the interest you actually earn. It deems your financial assets to earn 1.75% on the lower portion and 3.75% above that, whatever the bank pays. A term deposit paying 5.30% is therefore assessed on less income than it earns, which is helpful. But the balance still counts under the assets test, and deeming rates can change, so check where you stand before you act.

How are we thinking about it?

Our view is that cash is a tool, not a strategy. A buffer of one to three years of spending in cash or term deposits can let you ride out a market dip without selling growth assets at a bad time. It is a sensible piece of the plan. It isn't the whole plan.

What about those still paying off a home loan?

For many of our clients, and their adult children, rising rates mean a heavier mortgage. Shopping around and refinancing is a sensible response. But there is a trap we see often, and it has nothing to do with the interest rate.

What is the refinancing trap?

Most people compare the rate and the monthly repayment. Few look at the third number: how long the loan will take to pay off.

Here is a pattern we saw at a recent client review. Their mortgage broker had refinanced them onto a lower interest rate, which is a good outcome on its face. But when we read the paperwork, the new loan was set up over a fresh 30 years. They had already paid six years of their original 30-year loan, so they had about 24 years left. The refinance quietly added six years.

To be clear, we are financial advisers, not mortgage brokers, and the refinance was arranged by their broker. Our role is to look at how the loan fits the rest of their financial plan. The lower repayment was exactly what had caught their attention. The longer term was the part nobody had weighed up.

To show the effect, here are our figures for a $750,000 balance. We have used 6.5% p.a. on both loans so the only difference is the term. In real life the new rate would be lower, which helps, but it rarely makes up for six extra years:

That is roughly $408 a month of breathing room, in exchange for about $224,000 of extra interest. Repeat the exercise in a few years and a 30-year loan quietly becomes a 40-year loan. On a $1 million loan, the jump from 30 to 40 years adds around $535,000 in interest.

A longer term can be the right call if cash flow is tight. It just needs to be a decision, not an accident.

What did we do about it?

We ran a cash flow analysis with them. It showed they could comfortably afford more than the new minimum repayment. So rather than undoing the refinance, we suggested they open an offset account and pay in the same amount they would have been repaying on the old 24-year loan, about $408 a month more than the new minimum in our example.

An offset account is a transaction account linked to your home loan. Every dollar sitting in it reduces the balance your interest is charged on. Over time, putting the difference in the offset means they are broadly not paying more interest than they would have on the shorter loan. They also keep access to that money if life throws up a surprise, which is not the case when you pay extra straight into the loan. And because it is their own home loan, the interest they save is not taxable, so it works as a tax-free return. Interest earned on a term deposit, by comparison, is taxable.

They hadn't thought about it that way. They had planned to simply pay the minimum. The result is the best of both: a lower required repayment as a safety net, and a plan that still clears the debt on the original timeline.

It does take discipline, because the money only works if it stays in the offset. And not every loan has an offset account, or has one for free, so it is worth asking your lender or broker.

What about rolling other debts into the mortgage?

Debt consolidation, where a car or personal loan is folded into the home loan, can look attractive because the mortgage rate is lower. But car and personal loans usually run for five to seven years, while the mortgage runs for decades.

Take a $30,000 car loan with five years left, at 6.5% for comparison. Repaid over five years, it costs about $5,200 in interest and is gone. Folded into a 30-year mortgage, the same $30,000 costs about $38,300 in interest and follows you for three decades. That is roughly $33,000 more, even though the rate looks lower.

How can you get it right?

1. Look at the loan term as closely as the rate. Ask your lender for the remaining term and the total interest, not just the new repayment.
2. If you extend the term, set a plan to shorten it. Keep paying your old repayment where you can, or lift it when your income rises or costs ease.
3. Keep consolidated debt as its own loan split. It can still be secured by your home, but you can see it clearly and aim to clear it in the original timeframe.
4. Keep a cash buffer. Whether you are a retiree or a borrower, it gives you options when rates or markets move.

Conclusion

Higher rates are rewarding savers and squeezing borrowers, often in the same family. Debt is a tool, and cash is a tool. Both work best when they are part of a plan, and not a reaction to the latest headline.

If you would like a second set of eyes on your term deposits, your mortgage, or how the two fit together, we would be glad to help. Get in touch with our team at Malhi Private Wealth.

General advice warning: This article contains general information only and does not take into account your objectives, financial situation or needs. Before acting on any information, you should consider its appropriateness having regard to your own circumstances, and seek personal financial advice.

Malhi Wealth Management Pty Ltd ABN 633 146 433 ATF MJMalhi Family Trust ABN 56 973 759 569 t/a Malhi Private Wealth is a Corporate Authorised Representative (No. 001283127) of Provident Advisory Pty Ltd ABN 97 633 777 492 AFSL 549697 trading as Provident Advisory.

‍