Most families will tell you that one of the biggest financial decisions they will make in their lifetime will be the decision to buy a home. To do this, most families will take out a loan with their bank, also known as a mortgage.
When taking out a loan they need to carefully consider the following: can they afford to buy this home and do they have enough income to pay the interest on the loan?
Imagine the following: you’re in your car at a traffic light stop and the traffic lights ahead are all showing green. Fantastic, an easy journey ahead. This is what it can feel like when interest rates are low as they have been now for over a decade. Low rates can give you a sense that because the cost of money is cheap, you can increase the amount you borrow and in doing so take on more debt risk … what can possibly go wrong?
But what happens when interest rates start to rise? Can you still afford to pay the interest on that loan you took out on your house or houses? As interest rise you’ll have less money in your pocket, it’s as simple as that … but unfortunately time and time again too many people don’t plan for this scenario.
The US Mortgage Debt crisis which led to the 2008 financial crisis is the latest example of this. Tempted by low interest rates and cheap loans people took on much more debt than they could afford to service, so when Fed Chairman Alan Greenspan systematically raised US interest rates, tens of thousands of borrowers could not afford to pay the interest on their loans and eventually the mortgage debt market blew up with terrible consequences globally. Trillions of US Dollars were wiped out from the value global stock markets.
Reading through the transcripts of Federal Reserve meetings is arguably one of the most boring things that you can do! By any measure this is a tough read. But at Dominion this is exactly what we have been doing for decades. Interest rates movements are one of the most important contributors which shape the direction of any economy. They determine how much money you have in your pocket, how much money people can afford to spend, how much money people save, how much money companies are prepared to borrow to grow their businesses, how much money banks are prepared to lend and how much risk they are prepared to take on, how much money is invested in the stock market, how much income people have in their retirement and much more. Interest rates influence multiple asset classes and that is why at Dominion, as part of the management of the Dominion Capital Strategies Funds, we spend much time thinking about interest rates. So yes in our opinion interest rates are, by definition, interesting.
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