The time with really low interest rates will end sooner or later. It’s something we can be sure of. The question is only when and what will happen to the interest rate once it starts to rise. Sure, it has been nice to have cheap mortgages for a number of years, but there are both pros and cons to such a low-interest rate level. Now the interest rate may be on the rise and it is important that we keep track of what this means.
Low-interest rate level
The bank has had a negative interest rate on the repo rate for a long time now and this was really just a crisis measure to solve temporary problems. However, this record-low interest rate has clearly lasted longer than imagined. Although it seems that the bank has taken it very quietly and kept the interest rate down for longer than expected, there is a limit to everything. It is likely that that limit is now approaching the interest rate.
The US Federal Reserve Federal Reserve System, commonly called the Fed, has raised interest rates a number of times in recent years. Eight times since 2015 they have made increases. What happens in the US, which has a position where they affect the entire world, is clearly linked to Sweden and every time the Fed raises interest rates it becomes a little more likely that the bank will also start reviewing increases.
The last time it was a monetary policy meeting (September 6), the repo rate was left unchanged at -0.50 percent
At the time, however, it was said that the Swedish economy was strong and that inflation remained around the target of 2 percent, which is good indications. This means that one feels that the bank does not need as much support with monetary policy measures as it does to keep interest rates down.
They then said that they would like to keep the interest rate unchanged even at the next meeting in October, but are then open to start raising it slowly from December or maybe February next year. The forecast for the interest rate they have shared says that the interest rate may be back around zero in the third quarter of 2019.
In principle, there have been increases on the road since before, but when the Fed raises interest rates in the US it can create some pressure even on the bank, not to be too tough with raising in Sweden. It was already this monetary policy meeting that a couple of people wanted to see earlier increases. Deputy Governor Martin Flodén wanted an interest rate forecast that showed a rise in interest rates in October, while Henry Ohlsson had wanted to raise rates to -0.25 already at this meeting in September. This clearly indicates that things are about to happen.
What do interest rate hikes mean?
An important question is what would interest rates from the bank actually mean. What happens to me and my finances if interest rates go up? Although an increase would come, it does not mean major changes in the short term. 0.25 percent is not so much so there will be no major differences in the wallet directly. But in the long run, when interest rates go up, it obviously affects us all.
The main difference when the repo rate goes up is that the interest rate on loans also goes up. If it goes up as much or more is not entirely certain then the banks make their own choices, but somewhere around the same increase you have to count. Given that there is a forecast that aims to raise interest rates a lot in the long term, it will also become noticeable in the slightly longer term. For example, the bank’s forecast says that the repo rate will be 1.09 percent at the end of 2021. This is an increase of about 1.5 percent from today’s levels.
It may not sound like much with 1.5 per cent, but especially for home loans, every tenth of a percent is important, given the size of the loan. Given that the average interest rate on mortgages today is around 1.5 per cent, an increase of the same would mean that the mortgage rate falls to around 3 per cent. This is a doubling, which would also mean twice as much interest expense.
If you have a mortgage loan of SEK 2.5 million and with an interest rate of 1.5 percent, today you pay somewhere around SEK 3 125 per month in interest expense. With an interest rate of 3 percent, you instead pay the double, SEK 6,250. For a private economy with slightly more limited margins, this is not an insignificant difference. There is an additional SEK 3,000 to be paid out each month.
It is also conceivable that in the long term the interest rate on mortgages can go a little over 3 percent and end up at, for example, 5 or even 6 percent. If the interest rate were to go as high as 6 percent, the monthly cost for the same mortgage would be SEK 12,500 just for the interest rate. To this may be added amortization etc. Even though it is not likely that the interest rate will fall to 6 percent for a long time or if it even ends up there at all, there is always the risk, which you should consider. It has been so high before, no longer since 2008.
Given that this can be a big difference in interest costs and that far from everyone has large margins in their finances, interest rate increases can thus really affect our private economy in a significant way. There are certainly many who would not be able to afford an interest rate of up to 6 per cent and who would then have to find cheaper housing. For this reason, it is important that you plan ahead.
What you can do to prepare
The last thing you want is for the interest rate hikes to come as a shock and that you suddenly have higher expenses than you can afford. This is of course a very bad situation and therefore it is good to think through what you can do to avoid this and how to manage despite higher interest rates.
Fix the interest rate on the mortgage
A classic recipe to make sure you meet your living expenses is to simply fix the interest rate. For those of you who do not have such a good control of what this means, it is simply that the bank offers a so-called floating interest rate (which is actually tied to it too but only in three months) and then various fixed rates for 1, 2, 3 and 5 years, etc. The interest rates will then be exactly the same throughout the fixed term.
The disadvantage is that the fixed interest rates are often a little higher than the floating interest rates. This is because there is a certain degree of uncertainty and because the banks also weigh in how the interest rate may move in the future when they set the levels of the fixed interest rates. If it is likely that the interest rate will go up to 4 percent within a year, the fixed interest rate with a 1-year fixed term will of course reflect that.
In ordinary cases, it is usually said that in the long term the variable interest rate is lower than the fixed rate and that you save money on choosing a variable interest rate. However, this also means that you will be included in all the ups and downs and will also experience those high interest rates as they come. This works fine if you have good margins in your finances, but clearly works worse when you have small margins and just make it go together.
Anyone with a tight budget and not so much money left over can advantageously consider the fixed interest rate on the mortgage. Then you know exactly how much to pay each month during the binding period, you get no negative surprises and you can make a budget based on these expenses. You may not get the cheapest loan in total, but you avoid the unnecessary risk and know that you can afford to stay at least for the duration of the interest rate.
Plan your living expenses with larger margins
One way to prepare for higher interest rates is to make sure not to have too high housing costs and to have larger margins in their finances. Of course, anyone who gets a lot of money over a month and can save a lot will also have a clearer interest rate hike.
For this to be successful, step one is to choose a home that has a reasonable price and that ultimately lands at a reasonable monthly cost. The monthly cost of course depends on how much you pay when you buy a house or condominium. The more expensive housing the more you pay in interest. The more you have to repay as well. Although the amortization itself is to be counted as a saving, it is also a compelling saving and money that you have to shell out every month.
This means a higher total amount to be paid out. If you live in condominiums, you should also include for example the fee to the association and a house can have community fees etc. The total cost of such should of course be reasonable and that you get a good deal of money over each month. The less you get over, the greater the risk that you will have problems if the interest rate goes up.
For this very reason, banks tend to be tough when calculating how much you can borrow from them. They usually have an interest rate of up to 7 percent even. This means that it thinks you should be able to manage your finances even if interest rates reach 7 percent. It is not too likely, but if that happens, it is good to know that you can do it.
Unfortunately, many people do not have such large margins and would have problems if the interest rate went up to, for example, 6 percent. It is also not strange as there is a very large increase in costs. In our example earlier, for example, a loan of 2.5 million would mean an interest expense of SEK 12,500 if the interest rate lands at 6 percent.
There are probably many who would have trouble paying so much in interest. Certain groups are, of course, extra vulnerable, for example single people who have to account for the entire income themselves plus some other groups. Of course, it may not always be reasonable to plan for every extreme scenario, but it is important to make sure you have fairly good margins in your finances.
So don’t buy a home that is too expensive but think ahead and choose something that you can afford not only now but even if the interest rate would go up a few percent. It is better to be on the safe side and to have margins on their side in the private economy. The more you can save when the interest rate is low the better it is.
Add money to an interest buffer
As I just mentioned, it is a very good idea to save money when you have the opportunity. If you choose variable interest rates on your mortgages, you are sensitive to ups and downs and then you should think about a few things.
When the interest rate is low, you earn this if you have chosen a variable interest rate, then you can enjoy its benefits. In this situation, one should also use the low interest rate to save money. Right now, the mortgage interest rate is at very low levels and because it is so good you should also be able to save extra money (considering that you have obviously expected to manage clearly higher interest rates if you have to).
You should then ensure that some savings go to a so-called interest buffer, which is savings money that is entirely earmarked for future interest rate increases. It should be a kind of security on the day the interest rate rises substantially and your mortgage becomes more expensive. Then you can take money from this buffer if for some reason you notice that you have trouble managing interest costs within your regular monthly budget.
Of course, you aim to always be able to afford the mortgage within your regular budget, but if you feel that it is starting to get such high interest rates that it is starting to get tough, then you have an extra fund with money that can be used as support. This reduces the risk that you will have financial problems and you can hold out until the interest rate will hopefully go down a bit again.
Such a buffer is good for anyone who owns his or her home and has loans, but it is something that is especially recommended for those who have variable interest rates on the loans and who are then more affected by interest rate hikes. If you have fixed the interest rate, you are more confident when you will be able to keep the same interest until the maturity period expires. However, there is always a risk that you will receive an interest shock on the day the bond period actually ends, if the interest rate situation is clearly higher then than when you tied up the interest rate. Therefore, it does not hurt to have a savings that goes to an interest rate buffer or at least a general buffer, which can be used if there is a crisis.
One last thing to think about is how to “store” your buffer money. When the interest rate is as low as it is now, there is no interest at all on the savings account at your regular bank and then you get no return at all. It’s not super.
Think about when you might need your buffer money and if it’s a little further away you can either have them in a savings account with better interest rates at a niche bank or invest them in, for example, index funds. These are alternatives with a slightly longer savings horizon so if you think you need to use the buffer soon you should keep the money in the regular account. In the longer term, you can get clearly better returns by investing the money.
Pay on the mortgage
Spending money on saving a buffer is good but another good thing is to amortize. Paying off on loans is basically a saving and an investment. The money that you use to pay off a loan does not go away but makes the loan smaller. This means that the day you eg sell your home, it will be a smaller mortgage to settle and you will get more money.
In addition, you have to pay less in interest the smaller the loan and therefore you earn on paying off. The higher the interest rate, the more you will earn from amortization. So at present (with a mortgage interest rate of around 1.5 per cent) it may not be as much worth repaying as investing the money in ex funds, but when the interest rate goes up (to 4-5 per cent, for example) it will be worth so much more.
Since the interest rate will go up in time enough, it is not stupid to amortize, whether you need to or not according to the bank’s requirements. By doing so now you can be better prepared when interest rates go up and your loan becomes more expensive. The smaller your loan, the less you are affected by higher interest rates.
Ideally, you should both put money into an interest buffer and pay off extra now when the interest rate is low. It is now you have the best opportunity to get money over for amortization and savings. As long as the interest rate is as low as it is now, you have the chance to prepare for worse times.
If you have trouble saving money now because of small margins in your finances, it is quite certain that it will be even worse in the future, when interest rates go up. And it will definitely go up. So in such a situation you should try to look at what you can do to lower your costs, such as switching to a cheaper accommodation.