Investing advice: how to deal with rising interest rates
Tips on maintaining financial health in the face of increasing interest rates.
You’ve listened to the sage words of Alan Greenspan and you’ve read the Money and Investing section of the Wall Street Journal. You think that interest rates are heading up. The question is: what can you do to prepare your finances for higher rates? And, once you’ve minimized risks to your financial health, how can you actually capitalize on the high interest rates to come?
- Lock in lower mortgage rates
Congratulations if you already have a mortgage with a low, fixed interest rate. But if you don’t have a fixed-rate mortgage, obtaining one is the first thing you should do. When interest rates rise, payments on variable-rate mortgages rise. To avoid unpredictably large increases in your monthly mortgage payments, it is essential that you refinance your mortgage to a fixed-rate one as soon as possible.
Locking in lower mortgage rates has a corollary: stay in your current home. Mortgages and mortgage rates don’t move with you. As a result, if you move, you may be forced to pay a much higher interest rate on your new home. Furthermore, high interest rates will reduce the amount of money you can borrow to finance your home, because lenders will take increased interest expense into account when determining how much you can borrow. This makes “trading-up” less feasible in a high interest rate environment and can make “trading-down” more expensive than staying in your current home.
- Speed up credit card repayment
In terms of credit risk, the individual investor is a far cry from the UK Treasury. That’s why individual investors pay interest rates of 20% or more on their personal credit card debt. You may think this is the highest rates can go, but in fact your personal interest rates will likely increase along with increases in rates on Treasury securities. To avoid the specter of ever-increasing and never-ending minimum payments, take the initiative on paying down your credit .You'll thank yourself when rates begin to creep up.
- Avoid long-term bonds
Advice to avoid long-term bonds during periods of rising interest rates may seem a bit surprising. After all, you may think, if interest rates are going up then fixed- income securities (like UK Treasuries, for example) will be earning higher returns.
The problem with this logic is that you’re expecting interest rates to continue to rise beyond current levels. When interest rates rise, the price of bonds falls. Let’s illustrate with a concrete example. Let’s say you buy a bond that pays interest of 3% per year. Then, interest rates rise so that a bond with similar maturity and credit characteristics will yield 5%. Who would want to buy your bond at face value when they could buy a bond with a 5% yield? The answer is – no one. If you want to sell your bond, you will have to sell it for less than you paid in order to attract buyers. And with a longer-maturity bond, there is a greater chance that you will want to sell the bond before it comes due. In rising interest rate environments, long-term bonds can lose you money.
- Purchase variable-rate securities
Your finances will be reasonably safe in an increasing rate environment if you have a fixed-rate mortgage, low consumer debt and few long-term bonds. But what if you want to do more with your money than just be safe? One of the best ways to capitalize on increasing rate environments is to purchase variable-rate securities. These are bonds whose principal and interest adjust based on prevailing interest rates (usually measured by a Treasury security or a standard European rate.) In addition to corporate bonds, some kinds of mortgage-backed securities are variable-rate as well. These types of securities will automatically pay you higher rates as market interest rates increase.
Nation-wide prevailing interest rates can have a big effect on individual investors and consumers. It pays to carefully examine your financial holdings in the event of a series of interest rate hikes and make appropriate changes to your financial habits.
5 ways to identify stress
Some people show their anxiety outwardly, while others are able to repress it from the outside world.
Stress affects everyone in different ways. Some people show their anxiety outwardly, while others are able to repress it from the outside world—for a while at least. While it is true that people have varying thresholds for stress and that it manifests itself differently for each person, there are certain telltale signs of anxiety. Some of these signs are behavioural and some are physical. Here are five of the ways stress typical manifests itself on the human body and soul.
One of the chief indicators of a stressed out person is the inability to make decisions—particularly trivial ones that normally would not be met with hesitation. Stress attacks a person’s confidence and assertiveness, and as a result, a normally decisive person may waiver on choices, insignificant and significant alike. If you find yourself in a store having a mini-crisis over what colour scarf you should buy chances are it is not the winter apparel getting you down, rather, a deeper issue or a collection of stressful issues is bogging you down and clouding your mind.
Another prime indicator of high anxiety is a change in appetite. Usually a stressful situation will result in a loss of appetite; however, some people will seek solace and refuge in food.
Fatigue is another physical symptom of stress. Fatigue can be the result of being spread too thin at work or with personal problems. Insomnia, which can also be the byproduct of stress, will lead to fatigue during the day. The fatigue can be so pervasive that it affects the person both physically and mentally. Mental fatigue is tied in with the inability to make decisions and a person’s vulnerability to talking trivial matters way too seriously.
Changes in your body’s normal functions or appearance are signs of over-stress. Acne—zits or pimples—are more apt to show up on your face when you are stressed than if you are relaxed. Other skin blemishes may be indicators of anxiety as well. Nervous ticks may develop under great loads of stress. Your body’s digestive routine may be thrown off track under great stress as well. Diarrhea or constipation often accompany a time of great anxiety.
Under great stress a loss of appetite may be accompanied by a loss of humor. When a person is stressed out it can sometimes be difficult for him or her to see the lightness of an event or appreciate the humor in someone. Anxiety can stymie a person’s ability to see things in perspective and to distinguish between the serious and non-serious elements of life; and, as a result, nothing, or at least very little, is funny to a stressed out person.
How can you combat these stressed-out symptoms? The first thing to do is to take a deep breath. Deep breathing will send oxygen through your body and has a rejuvenating effect on your organs. Practice long and deep breaths whenever you have spare time. Second, go for a run. You do not need to run the marathon, but exercising for twenty to thirty minutes will not only jumpstart your body, but will give your mind a holiday from your stressful thoughts. Taking time out of the day for a long shower or bath can be a good de-stressor.
Keeping a journal of your feelings can be helpful in identifying the stress-catalysts in your life. Make sure you include what you did that day and how each event, encounter, or activity made you feel—physically and emotionally. In addition, having someone to talk to abut your problems is crucial if you find yourself stressed out. While a good friend or relative is an excellent resource, finding strangers with similar problems through can be beneficial as well. You can do this easily by looking into or joining online forums. Since stress often exists in or is caused by personal relationships between close friends or family members an outside source may be a better option.
Unless you have decided to take a vacation on a Caribbean island for a week,(which you should do if you can) it is a good idea to stay away from depressants like alcohol when you are stressed. Cracking open a beer after work may seem like a good idea when you are under great pressure but it can have a snowball effect that may send you deeper into your frenzied or depressed mood.
The last, and perhaps most important piece of advice is to get some sleep. Studies show that stress levels are typically higher people who do not get enough sleep. Buy a new down-blanket or splurge on that waterbed you’ve always had your eye on—whatever it takes—your body and mind will thank you when you feel well-rested and ready to take on the day in the morning.
Capital Gains Tax Trap
Given the property boom over recent years, a huge number of investors have quickly and successfully grown portfolios by using a very simple investment strategy. This strategy involves withdrawing equity from an existing property to fund the next purchase.
Though this strategy has been successfully used to quickly grow portfolios and increase the number of millionaires in the country, it is has already caused and continues to cause severe CGT implications for a growing number of investors.
Consider the following case study:
She buys her first two-bed terraced investment property in January 1996 for £60,000.
This is funded by a £12,000 deposit and a £48,000 buy-to-let mortgage. In January 2000, the property is valued at £100,000, so she decides to fund her next investment property by releasing equity from the existing one.
Her mortgage lender allows her to increase her mortgage borrowing to £80,000 (i.e. 80% of the property value) and therefore she is able to buy a £150,000 three bedroom detached property with the 20% deposit funded by the equity release.
Now there is one very important point to note about the above case study. This is that there is no capital gains tax (CGT) liability due when the property is re mortgaged. CGT is only due when the property is sold or transferred. So what this effectively means is that she is able to extract large sums of money from her property without paying a single penny in tax. In fact, even if she had used the equity release proceeds for a cruise around the world then still no CGT liability would have been triggered.
However, this is a very risky strategy as we are about to realise.
She continues her portfolio growth
In 2002, her first property is worth £150,000 and the second property is worth £200,000. Again she decides to grow her property portfolio and re mortgages the existing properties. She again releases equity to fund FIVE new apartment purchases at £125,000 in the North of England.
Due to the competitive buy-to-let market she is now able to re mortgage the properties to 85% of the property value. This means that on her first property she is able to increase her borrowing to £127,500 – more than twice what she originally purchased the property for.
So she now has FIVE properties with a market value of £125,000, one at £150,000 and another at £200,000. Her total portfolio is worth £975,000 – almost a property millionaire!
She becomes a property millionaire!
By 2004, the north has had two years of excellent property capital growth and the apartments purchased at £125,000 are now worth £175,000 each, her two bed terraced property is now valued at £175,000 and three bed detached property is valued at £250,000.
She is now a property millionaire!
Again, is keen to continue the growth of her property portfolio and once again takes advantage of the 85% equity release available and remortgages all the properties to 85% loan to value and invests in three Villas one in each of Spain, France and Cyprus for £250,000 each.
So to summarise this is the current state of her property portfolio:
Two bed terraced property: Purchased for £60,000. Current value of £175,000 with outstanding mortgage of £148,750
Three bed detached property: Purchased for £150,000. Current value of £250,000 with outstanding mortgage of £212,500
FIVE Apartments: Purchased for £125,000 each. Current value of £175,000 each with an outstanding mortgage of £148,750.
THREE villas in non-UK countries valued at a total of £750,000.
So in total here portfolio is now worth over £2 million and she has become a multi-millionaire.
So what does all this mean?
Well, firstly it means that she, has grown a very sizeable portfolio in a few years and has indeed become a property millionaire (well on paper anyway!).
However, she has never considered her capital gains tax position during her continued investment, and this means that on each of her UK owned properties she actually now owes more than what she originally paid for the property.
This in turn means that unless she has a considerable amount of savings she is unlikely to be able to pay the CGT bill on the sale of the property from the actual sales proceeds.
Lets take the example of her very first investment property, which she purchased in 1996 for £60,000. If she sells at the current market value of £175,000 then she has made a £115,000 capital gain (minus her annual CGT exemption of £8,200) and could be liable to pay tax of 40% (i.e. £42,720) of this amount (ignoring the deductions for indexation and taper relief and costs).
However, given that she only has £26,500 of equity in the property she will be required to find an extra £16,220 just to pay the taxman, thus meaning she has made no actual profit and could incur additional debt paying the taxman. She may think that she can sell another of her properties to fund the required £16,220, but again she will face the same problem, where the sale of the property will not cover its own CGT liability.
Now, if for some reason she needed to sell all her properties then you could see how she could end up paying the taxman quite a considerable amount of money, and have nothing to show for it herself at the end of it.
So, although Aleesha is a millionaire property investor, she could up without a penny to her name and with significant debts if she decides to sell.
Her foreign properties do not help her either, as there is local CGT (often a compulsory withholding of a percentage of the sale proceeds) and the balance due to the taxman here after deducting the foreign tax she has had to pay.
How to overcome the problem?
There are a number of ways to tackle this tax problem and these are outlined below:
Firstly, she could decide not to purchase anymore properties and continue to just hold the properties and wait till they have increased in value, or if purchased with repayment mortgages, enough of the loans have been repaid; that the sales proceeds could cover any tax liability quite comfortably. However this may take 5, 10, or 20 more years! One tax advantage of waiting is that after 10 years of ownership of each property; by virtue of taper relief the CGT rate will reduce from 40% to 24%.
Secondly, she could leave the UK for 5 complete tax years and then sell the properties in either the tax year following her year of departure and any of the next 4 tax years. By doing this she would wipe-out any UK CGT liability. Given that six million UK residents are expected to emigrate by the year 2020 this could be her chosen option. Also, she may quite fancy living in one of her foreign properties. She would also have to consider local CGT in her new Country of residence, on her UK property sales. This would be 15% in Spain. In France, she would at present have no CGT on her UK properties (this may change!) and in Cyprus she would have to pay 20%.
Thirdly, she could avoid CGT, if her properties taken together were considered to be a “Business”. She could then transfer them into a Company and claim Incorporation Relief. This would have the effect of enabling the Company to sell the properties with little or no CGT liability.
Investing advice: how to deal with rising interest rates
Tips on maintaining financial health in the face of increasing interest rates.
You’ve listened to the sage words of Alan Greenspan and you’ve read the Money and Investing section of the Wall Street Journal. You think that interest rates are heading up. The question is: what can you do to prepare your finances for higher rates? And, once you’ve minimized risks to your financial health, how can you actually capitalize on the high interest rates to come?
- Lock in lower mortgage rates
Congratulations if you already have a mortgage with a low, fixed interest rate. But if you don’t have a fixed-rate mortgage, obtaining one is the first thing you should do. When interest rates rise, payments on variable-rate mortgages rise. To avoid unpredictably large increases in your monthly mortgage payments, it is essential that you refinance your mortgage to a fixed-rate one as soon as possible.
Locking in lower mortgage rates has a corollary: stay in your current home. Mortgages and mortgage rates don’t move with you. As a result, if you move, you may be forced to pay a much higher interest rate on your new home. Furthermore, high interest rates will reduce the amount of money you can borrow to finance your home, because lenders will take increased interest expense into account when determining how much you can borrow. This makes “trading-up” less feasible in a high interest rate environment and can make “trading-down” more expensive than staying in your current home.
- Speed up credit card repayment
In terms of credit risk, the individual investor is a far cry from the UK Treasury. That’s why individual investors pay interest rates of 20% or more on their personal credit card debt. You may think this is the highest rates can go, but in fact your personal interest rates will likely increase along with increases in rates on Treasury securities. To avoid the specter of ever-increasing and never-ending minimum payments, take the initiative on paying down your credit. You’ll thank yourself when rates begin to creep up.
- Avoid long-term bonds
Advice to avoid long-term bonds during periods of rising interest rates may seem a bit surprising. After all, you may think, if interest rates are going up then fixed- income securities (like UK Treasuries, for example) will be earning higher returns.
The problem with this logic is that you’re expecting interest rates to continue to rise beyond current levels. When interest rates rise, the price of bonds falls. Let’s illustrate with a concrete example. Let’s say you buy a bond that pays interest of 3% per year. Then, interest rates rise so that a bond with similar maturity and credit characteristics will yield 5%. Who would want to buy your bond at face value when they could buy a bond with a 5% yield? The answer is – no one. If you want to sell your bond, you will have to sell it for less than you paid in order to attract buyers. And with a longer-maturity bond, there is a greater chance that you will want to sell the bond before it comes due. In rising interest rate environments, long-term bonds can lose you money.
- Purchase variable-rate securities
Your finances will be reasonably safe in an increasing rate environment if you have a fixed-rate mortgage, low consumer debt and few long-term bonds. But what if you want to do more with your money than just be safe? One of the best ways to capitalize on increasing rate environments is to purchase variable-rate securities. These are bonds whose principal and interest adjust based on prevailing interest rates (usually measured by a Treasury security or a standard European rate.) In addition to corporate bonds, some kinds of mortgage-backed securities are variable-rate as well. These types of securities will automatically pay you higher rates as market interest rates increase.
Nation-wide prevailing interest rates can have a big effect on individual investors and consumers. It pays to carefully examine your financial holdings in the event of a series of interest rate hikes and make appropriate changes to your financial habits.
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