John McGrath – How to cope with interest rate rises
For the past couple of years, historically low interest rates have provided the opportunity of a lifetime for every single home owner and new buyer in the property market.
Many owners have paid down debt, while others have built up their offset accounts. The ability to borrow more has enabled many buyers to enter the market, or upgrade an existing home, sooner than expected.
But we’ve known for a while now that the only way from here is up with interest rates. Things changed in June last year when the Reserve Bank (RBA) closed the Term Funding Facility. The TFF gave banks local access to billions of dollars, at an extremely low fixed rate for three years, to enable them to comfortably continue with home and business lending during the peak period of COVID-19.
Since then, while the official cash rate remained at 0.1% until this month, the banks have slowly started to lift both fixed and variable mortgage rates. Then this month, the RBA raised the official rate from 0.1% to 0.35%, mainly due to inflation, and every bank followed suit. And the RBA Governor indicated that there will be more rate rises ahead.
I think it’s very likely the banks will continue to adjust their rates upwards, with or without the RBA moving first, as the cost of funding normalises again.
So this week, we’re going to look at what you can do to cope with a rising interest rate environment. This is really important for younger owners to think about because it’s a big change in the economic landscape. The last time the RBA increased the official cash rate was in November 2010. Since then, hundreds of thousands of first home buyers and first-time investors have bought property, and they’ve never had to deal with rising interest costs.
The long-term average home loan rate in Australia is in the 7% range. Right now, these young owners are used to home loans in the 2% range, however they should prepare themselves for likely increases over the next couple of years. While it may not be imminent, the time to get your head around this and prepare for it is now.
I’ve discussed this with award winning mortgage broking expert, Fabio DeCastro from Oxygen Home Loans. I asked him to answer the main questions on the minds of young owners and buyers today.
JM: How do rising interest rates impact how much you can borrow?
Fabio: Interest rate rises have a real impact on your borrowing ability because the banks assess your capacity to make your repayments based on the actual rate of the loan you are applying for plus a buffer of around 3%. For example, a customer who was approved for a maximum loan amount of $600,000 will now be assessed and approved for only $581,000 following the 0.25% rate rise this month.
JM: What is the common mortgage loan rate range for fixed and variable home and investment loans?
Fabio: The most common mortgage loan rate for two-year fixed home loans among the major banks is the high 3% range, and three-year rates are now in the low to mid 4% range. Longer terms are higher. Variable home loan rates among the majors are 2.29% to 3.49%, with rates from smaller lenders in the low 2% range.
For a two-year fixed investment loan among the majors, you’re looking at the low 4% range, and three-year rates are in the mid-4% range. Again, longer terms are higher. Variable investment loan rates among the majors are 3.49% to 3.99%; with rates from smaller lenders in the low 3% range.
JM: What are your best tips for coping with a rising interest rate environment?
Fabio: Here are three great tips in the current environment.
- Seek help from a professional to understand your situation – everyone’s details and circumstances are different – which often means a different solution
- If you’re on a variable rate, have a look at your budget and make extra repayments on your current loan, if you’re able to. This way you can get accustomed to future rises now, with less impact in the future
- Be aware of fixed rates – they have limited flexibility, such as no offset account, and lock you in for a specific term.
Next week, Fabio and I will discuss the ‘lender loyalty tax’ and how you can save thousands of dollars by walking away from lenders who won’t give you as good a deal as their new customers.