How will you cope with rising interest rates?

Interest rates are at all-time lows, but they won’t stay there forever.

At some stage, the Reserve Bank of Australia (RBA) will raise the official cash rate, which could be bad news for the stockmarket and your portfolio.

That time might not come until 2017 or even further out, and we could see interest rates fall in the short to medium-term. But clearly, an official cash rate of 2% is very low – as are mortgage interest rates of 5% or less.

Over the long term (since 1990), the average RBA cash rate is 5.4% – more than double the existing rate. The average standard variable mortgage rate over the same period is just under 8%.

RBA official cash rate 1990 to Nov 2015

Source: RBA

Here are some things you need to be thinking about long-term.

When interest rates do rise, so will your mortgage rates. In fact, the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) have already begun raising mortgage rates for many borrowers, not just investors.

That has more to do with shoring up their balance sheets, and maintaining their existing returns on equity, thanks to higher capital requirements. Should the banks be forced to raise more capital, interest rates on mortgages are likely to rise again. Whether the banks also raise rates on term deposits and bank accounts is another question – but appears unlikely.

It means you will be paying more out in interest on your mortgage. How would you cope with a mortgage rate of 8%? It certainly means higher monthly repayments.

Higher rates will also mean other assets such as bonds and fixed income become more attractive – which could see billions flow out of the stockmarket and into those asset classes. It also pays to remember that the stockmarket is forward-looking, with share prices reflecting the future earnings potential. The prospect of rising interest rates may impact on shares long before they happen.

Dividend yield stocks won’t look so attractive then and investors may switch their focus from yield to growth. Companies like the big four banks, Telstra Corporation Ltd (ASX: TLS) and Wesfarmers Ltd (ASX: WES) with low growth expectations could see investors sell out.

Higher interest rates could also see the Australian dollar rise, which may negate the current tailwinds Australian commodities producers such as iron ore, gold miners and energy companies are currently experiencing.

In Australian dollar terms, oil is fetching $61.25 a barrel, iron ore $64 a tonne and gold more than $1,500 an ounce.

Foolish takeaway

Interest rates will rise at some stage, that’s a fact. When – I have no idea, but it pays to make sure you are aware of how it will affect you and a portfolio of Australian equities.

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Motley Fool contributor Mike King owns shares in Telstra and Wesfarmers. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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