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Don't underestimate the interest rate effect

by , 28 January 2021
Don't underestimate the interest rate effect
Interest rates in SA are at a generational low - this might be the lowest we'll see them for many years to come. And while the opportunity is here - it's clear that many home buyers and businesses are grabbing it.

A recent report from bond originator, OOBA, shows that in the fourth quarter of 2020 home loan applications shot up a whopping 36% compared to the same quarter in 2019.

The majority of these are first time home buyers and they are applying for between R500,000 and R2 million in funding.

According to OOBA, roughly 60% of all applications are currently first-time buyers. What's more - roughly 80% of these applications are being approved!

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50-year low interest rates have saved the SA economy
Property prices would’ve fallen deeply following the lockdown in 2020 – if the South African interest rate hadn’t been dropped to a 50-year low.
Instead, the residential real estate market across the country has ridden a wave of demand driven by historically low interest rates.
It’s improved affordability and allowed landlords and homeowners to pay off properties faster than they would’ve been able to otherwise (if they had income to do so).
Similarly, JSE listed property companies have seen a pause on lending rates – even though their credit ratings might have been downgraded.
So what does this mean to investors right now?
Despite the fact that demand for affordable properties is high right now – you shouldn’t charge out and buy. Instead – rather make use of low interest rates to de-gear your property portfolio or your personal home loan.
You could get better returns elsewhere right now – but the fact of the matter is that these low interest rates won’t be forever.
Inflation is turning – and in six to twelve months’ time the historic low inflation rate we had at the end of 2020 will be a thing of the past and higher inflation will put pressure on the SA Reserve Bank to increase interest rates again.
With interest rates being cut 3% due to the pandemic – they could easily be increase by 3% - even as much as 5% again as they turn. Higher interest rates were on the cards before the pandemic hit in any case.
So ask yourself – if interest rates increase by 5% from here, which means they are nearly double… Can you still afford your debt?

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When investing in stocks – make sure you look at this figure
The same rules that count for your personal finances count for businesses.
You want to invest in companies that are paying off debt right now.
For instance Pan African Resources just announced that it cut debt by 47% from $123.7 million to $65.2 million in the past six months. That means debt reduction of nearly R900 million in SIX MONTHS! And the company managed this whilst it has got expansion projects running.
A useful tool you can use is called the Current Ratio.
This ratio tells you how much of the business’ current assets covers the debt it has to repay in the coming year:
Current ratio: Current assets / Current Liabilities
Basically this ratio measures a company’s ability to pay off debt with cash and inventory on hand.
If you were a company the current ratio would be your ability to pay day-to-day living costs.
So, you need to pay R120,000 of repayments on your bond this year but you only have R50,000 in investments and cash in the bank.
Your current ratio would be = (R50,000) / (R120,000) = 0.42
When your current ratio is below 1 it means you cannot pay all your required payments for the year with cash and investments you have on hand. That means you will have a liquidity problem if you lose your job – because without your salary you cannot survive for a year.
In the same way – a company with a current ratio above 1 can possibly survive longer than a year without extra income.
Remember – low interest rates mean higher disposable or free income for both you and businesses. But similarly – a turn in interest rates will have a highly negative effect on your cashflows as well – so make sure you, and the companies you invest in, are covered in the case of a turn in the interest rate…
Here’s to unleashing real value
Francois Joubert
Editor, Red Hot Penny Shares

Don't underestimate the interest rate effect
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