With official interest rates at historic lows of 2%, there are pervasive impacts on the economy. But while low rates are designed to boost economic activity, there are substantial negative impacts on certain segments of society — and the result isn't always very fair.
For the couple paying off a mortgage on a house they bought ten or twenty years ago, lower rates is all upside. A lower rate reduces those interest payments and puts upward pressure on house prices, making that older couple richer on paper and – due to lower interest payments – quite immediately boosts their spending money (or means they can pay off that loan more quickly).
On the other hand, retirees living in their own home off the income from term deposits, are seen as victims. Lifelong savers, these people have too much cash to deserve the pension, but increasingly can't afford to live off the interest, due to high medical costs. Worryingly, they are eating into their principle. They understandably receive considerable sympathy.
That's fair enough, but we hear a less about the impact on young adults. Still studying, or at the beginning of their careers, they are saving for a house deposit, often with a partner or spouse. The only problem is, their savings don't earn more than 3% in the bank, and – even putting aside a generous portion of their moderate pay package – house prices seem to outstrip even their best efforts at saving.
Big city property booming
House prices across the 5 largest capital cities are up 8% in the last year. Sydney has seen faster growth, with prices up 14.2% in the 12 months to June, according to data from CoreLogic. There's little doubt this growth has been assisted by successive interest rate cuts. As a result, many young couples working in east coast cities, hoping to build their own nest, face little prospect of success in that regard. At least, not without some help from Mum and Dad.
Unfortunately, this leads to inequitable outcomes. Since support from Mum and Dad is now important in getting into the property market, young couples who don't get that help are faced with significant hurdles to home ownership. This is particularly true in Sydney or Melbourne, and it puts great importance on the luck of birth, and less on merit. Is that the kind of society we want?
Adding insult to injury, some say that lower interest rates are to their advantage and that they should "get a good job". After all, they are told, that will allow them to borrow more money. While true, this fact is hardly good news. It isn't just first home buyers who can afford to borrow more with low rates. It's everyone, including investors. And those same investors also benefit from the tax break afforded by negative gearing.
Indeed, for almost two years now investors have been taking out more mortgages than first home buyers. For the entirety of 2015, first home buyers have accounted for less than a third of new Australian mortgages, according to data from the Australian Finance Group. That's a strong indication that investors are crowding first home buyers out of the market.
Are there better options?
With record low interest rates offering a paltry return on savings, it is increasingly attractive for would-be first home buyers to postpone that ambition and invest in shares instead. With shares in high quality companies yielding considerably more than term deposits, the benefits of compounding are not out of their reach.
In fact, sharemarket investing is one area where a younger generation may have an advantage because statistics demonstrate that the length of time owning shares is one of the most reliable indicators of overall returns. With relative youth comes a relatively long time horizon during which a high quality business with honest and competent managers can generate value for its shareholders.
Foolish takeaway
Ironically, buying shares is one way of benefiting from lower interest rates, or at least overcome them, because lower interest rates tend to inflate share prices, and many companies pay dividend yields well in excess of your average term deposit.
By investing in a sensibly diversified portfolio of shares, younger people can position themselves to benefit from lower interest rates without taking out a 30 year loan. After all, a recent study from New York University found Sydney housing to be the third-least affordable in the world, with Melbourne not far behind at sixth — and it may not be safe to assume that property values will keep rising indefinitely!
