Every investor would (and should) know by now that interest rates are at record lows. The Reserve Bank of Australia (RBA) has now cut interest rates 3 times this year – leaving the cash rate at 0.75%. Many experts are predicting this could go as low as 0.5% by February next year, if not sooner.
For many people, this might seem like a wondrous time. Your average new mortgage these days is issued with an interest rate under 4%, and often lower. Likewise, if you want to borrow money to invest in shares (a margin loan) or start a business, capital has never been cheaper.
The typical downside from these low interest rates is the low returns you can now expect to see from cash investments and government bonds. This has hit capital-conservative investors like retirees hardest, although no one really likes to get nothing for having money in the bank.
But that isn't the biggest danger with low interest rates, in my opinion.
There's a good reason why property prices have taken off again this year in conjunction with the share market reaching record highs – and it's not really related to our economy. Interest rates are directly correlated to the prices of other financial assets. If the 'risk-free' rate you can expect to earn from a government bond is lower, it raises the intrinsic value of other riskier assets – assets like shares and property.
This means that although first home buyers have never enjoyed cheaper mortgages over the last couple of years, they have also never had more expensive houses to choose from. Imagine if interest rates start rising in the next couple of years – it's going to get ugly for anyone who's just signed an $800,000 mortgage.
Foolish takeaway
Investors have a nasty tendency to assume the status quo will never change. If you're thinking that low interest rates make this a great time to buy property, make sure you can account for interest rates returning to the levels we saw before the GFC someday.
