There is no way to accurately predict when interest rates will rise, but there are signs that a hike may be coming as soon as August 2022. The question on every homeowner, property investor and first home buyers mind are: When will official interest rates rise and how should prepare before it hits?
Covid-19 and the impact on future interest rates rises
Average mortgage sizes are so much bigger today than they were 5 years ago, and the RBA simply won’t need to lift interest rates as aggressively as in the past. Therefore the total size of future rate hikes is likely to be moderate.
Many families have accumulated significant savings buffers during the COVID-19 pandemic, are paying off their mortgages faster than required by their lenders, and have accumulated significant sums in mortgage offset accounts.
What happens to your home loan when the cash rate rises?
- If you’re on a variable rate home loan and your lender chooses to hike rates in line with the cash rate, then your interest rate – and therefore your monthly mortgage repayments will increase
- If you’re currently on a fixed rate home loan, your interest rate will not change for the fixed term duration you have agreed to. However, once this fixed term ends, you may find that your home loan reverts to the lenders’ standard variable rate. This may be higher than your current fixed rate, and your mortgage repayments may increase too
Tip: If you are already making above-minimum repayments, your lender may not have to increase your actual repayments for some time after interest rates rise.
What’s the difference between Fixed and Variable rates – Learn more here
Interest rises | Investment Property owners
The effect of interest rate rises on property investors could go multiple ways. Higher interest rates, allied to continually rising house prices and tighter lending conditions, could improve the position of investors against first home buyers, particularly in regional areas. Higher mortgage interest rates will affect cash flow for property investors but surging rents and larger buffers may help cushion that blow, experts say.
Cash flow is comfortable for most existing investors due to record low mortgage rates and rising rents. Some investors may aim to increase their rents when the next rental review comes around. On the other hand, property investors pay higher interest rates than owner-occupiers, meaning that any hike in rates may hit harder.
There will be a knock-on effect on people’s ability to borrow as borrowing power is calculated based on the interest rate on top of a borrower’s buffer rate and borrowing capacity may be slightly weaker.
Tips to prepare for a rise in interest rates
1. Make extra repayments with an offset account
If you’re currently making minimum loan repayments, making extra repayments can help you minimise your loan and reduce the overall interest payable on your home loan. If your lender allows for extra repayments without penalty, then acting now to chip away at your loan principal with additional payments may be worth considering using an offset account.
An offset account is a linked transaction account to your home loan. Unlike extra repayments which chip away at your principal, the funds you deposit in your offset account work to ‘offset’ or reduce the amount you pay in interest. You have the added bonus of being able to potentially withdraw these funds if needed, such as for a home renovation.
2. Switch from variable to a fixed rate
The idea of switching to a fixed rate, allows you to lock in an interest rate for anywhere between 2-3 years. It gives you certainty over your repayments and peace of mind if you have other expenses to deal with.
The drawback is that it limits your ability to make extra repayments and the lender will charge you if you decide later to refinance within the fixed period.
Tip: You may better off switching just a portion of your home loan, so you have some flexibility and certainty.
3. Choose P&I over IO repayments
If you have an investment property, you might want to think about switching from interest only (IO) to principal and interest (P&I) because interest only rates tend to be much higher than principal and interest (P&I) repayments. They also tend to be the first rates to rise when a hike is around the corner.
Tip: Switching to interest only because you can’t afford P&I repayments is not a good long-term strategy because you end up paying more over the life of the loan.
4. Consider refinancing
If your lender hikes your interest rate past a point that you can comfortably service, and you’ve been repaying your mortgage for several years with some equity built up, it may be worth researching lower-rate lenders.
Refinancing to a lower-rate home loan may be one option to give yourself a rate cut in a time of increasing interest rates. For example, the average owner-occupier variable interest rate in January (paying principal and interest) sat at 3.10%.
5. Don’t live beyond your means
One of the most common mistakes that people make when it comes to preparing for an interest rate rise is that they spend more than they can afford. In the short-term, this could see you miss or default on your mortgage repayments. Over the long-term, high living expenses can affect your chances at refinancing your home loan to get a sharper rate.
6. Accessing your redraw facility on a regular basis
Withdrawing extra repayments you have made to your offset is a better strategy than constantly withdrawing from your redraw facility. The fees can be quite high each time you withdraw using your redraw facility, whereas an offset account typically has free withdrawal.
7. Review your loan regularly
Most people are unprepared because they simply get apathetic about their mortgage and forget to check their rate on a regular basis. The fact is that the lender will not notify you when your rate has risen. The simplest step you can take is to call a mortgage broker to find out if you’re eligible for a cheaper rate with another lender.
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Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.
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