As major banks raise fixed rates and dramatically cut variable rates, many borrowers may reconsider variable rate home loans. But with nearly one in four new mortgages taking on dangerous levels of debt and banks predicting interest rates could start to rise as early as June 2022, what steps can you take to help minimize the risk of shock? before the next rate hike?
What makes interest rates go up?
Interest rates can go up and down depending on a wide range of factors, from the cost of overseas funding for banks to the current state of the Australian economy. An important factor to consider is the national exchange rate, set by the Reserve Bank of Australia (RBA).
The cash rate is the interest rate at which banks charge each other for overnight cash loans, which they use to provide financial products and services to their customers. The higher the cash rate, the more it can cost banks to provide these products and services, and the more interest they can charge on loans as a result.
How might rising interest rates affect me?
The repayment of a typical home loan consists of a small portion of the outstanding mortgage amount (the principal) and interest charges. Over the term of the loan (often 20-30 years), these principal and interest payments will slowly but surely pay off the mortgage on the property.
Many Australian home loans have variable interest rates, where the amount of interest charged on each repayment can change over the term of the loan. If the RBA raises the national cash rate and your mortgage lender passes on that change in the form of higher interest rates, your home loan repayments will likely increase.
The exception is if you have a fixed rate home loan, where your interest rate is locked in for a predetermined length of time. Until the end of your fixed rate period, your home loan payments will remain the same whether your lender raises or lowers their variable rates. Once the fixed term expires, your loan will revert to the lender’s variable rate, which may have changed significantly.
Will a fall in rates reduce the repayments of my mortgage?
Often not. Not all lenders will automatically reduce your monthly payment when they reduce your interest rate – you may need to contact your lender and ask them specifically if you would prefer to pay less month to month.
In many cases, your lender will default you to the same regular repayment amount, with a smaller percentage being made up of interest charges and a larger percentage being used to pay down your mortgage principal. While you can’t save money month over month, it can help you pay off your mortgage faster, so you can potentially save money on interest charges at long term.
What can I do against rising rates?
When applying for a home loan, mortgage lenders are required to verify that you can not only afford the repayments today, but in the future should rates rise. That said, many Australians have never experienced rising interest rates before, and the effect on household budgets could potentially leave many at risk of mortgage stress.
There are a few different options you could potentially pursue to help weather the storm of rising rates:
Make additional repayments today
If your home loan interest rates are currently low, it may be a little easier to put some extra money on your mortgage. This can mean adding a little extra to each monthly repayment or paying a lump sum when you have extra money, like a tax refund. Getting ahead of your repayments like this can give you an extra buffer in case you run into financial trouble in the future.
You may want to check if your lender imposes any restrictions on additional repayments (fixed rate loans are often less flexible than variable rate loans), and whether you will be able to access these additional repayments in the future if needed by using a withdraw function. Another option might be to put extra money in an offset account, which can help reduce your interest charges while keeping your money easily accessible.
If your lender’s interest rates are high, you may have the option of switching and saving with another bank or mortgage lender. Even when interest rates rise, there are competitive home loan deals available from various mortgage lenders.
If you have already made additional repayments, you may have accumulated additional equity in your property. This can often help you qualify for more competitive mortgage offers when you refinance, whether you’re looking for lower interest rates or features and benefits better suited to your financial situation.
Keep in mind that refinancing isn’t always the best option for every home loan. For example, if you’re on a fixed interest rate, refinancing could mean paying significant break-up fees.
Contact an expert
If you’re worried that rising interest rates will leave you in mortgage stress, you can contact your lender’s difficulty management team about other options that might help you manage your mortgage expenses, such as switching to interest-only repayments or taking a repayment holiday for a limited time. Of course, these options could have longer-term effects on the cost of your home loan.
A mortgage broker may be able to advise you if there are other home loan options available that might better suit your budget and financial situation.
If things are looking bad, a financial advisor may be able to help you find options to get your money back on track.