With interest rates looking like they’re on the rise in Australia, it’s worth asking yourself how your finances would handle a rate increase. You are likely to find out the answer to that soon enough, with the increase expected to occur by mid-year, ahead of schedule. This year will bring with it four rate rises, according to the major banks.i
It pays to be prepared, so now is a good time to consider a fixed rate loan if you haven’t already. You might think it’s too late, as fixed rates have already started increasing, following record lows last year. It is a different story now, with Canstar finding that 19 providers have increased 513 fixed rates by an average of 0.35 percentage points.ii
It can still prove savvy to make the switch, bearing in mind the following pros and cons and taking into consideration your financial situation.
The pros and cons of a fixed rate
Fixed rates have grown in popularity in recent times. While 20% of outstanding mortgages were fixed mortgages in pre-pandemic times, they now make up 35%, with first home buyers most likely to fix rates.iii
As the name suggests, with this type of loan, your interest rate and repayments remain the same during the fixed term. This obviously is a good thing in the case of impending rate rises, as is being predicted for 2022, as it offers protection against these.
It can also make budgeting and planning more straightforward, as you will know exactly what your payments will be during the fixed period, so there shouldn’t be any nasty surprises.
While fixed rate loans tend to be seen as the ‘safer’ option, they do have their drawbacks. For instance, you may be unable to make additional repayments during the fixed term, which might not be ideal should you be able to pay off the loan more quickly. And should interest rates drop, you’ll lose the opportunity to receive better rates.
It can mean having to pay break fees if you want to re-mortgage; as is the case if you want to swap to a variable rate. You may also have fewer features with a fixed rate loan, so if you need redraw facilities for example, you may be better served with a variable loan.
Impact of rate increases on monthly repayment
| Rate | Monthly repayment | Increase in monthly repayments | |
| Average variable rate | 3.02% | $2,113 | – |
| Plus 0.25 pps | 3.27% | $2,182 | $69 |
| Plus 0.50 pps | 3.52% | $2,251 | $138 |
| Plus 0.75 pps | 3.77% | $2,321 | $208 |
| Plus 1.00 pps | 4.02% | $2,393 | $280 |
Source: www.canstar.com.au – 21/02/2022. Average variable rate based on owner-occupier variable loans on Canstar’s database, available for a loan amount of $500,000, at 80% LVR with principal & interest repayments. Monthly repayment calculations exclude fees and assume principal and interest repayments on a $500,000 loan made over a total loan term of 30 years.
Exploring your options
It might make financial sense for you to have a fixed rate, however you don’t have to go all in. You can split the loan to have a fixed rate component as well as a variable rate. That way you can get the best of both loan options, this may soften the impact of any of the previously mentioned drawbacks of a fixed interest rate.
You can select the proportion to fix so you can find an arrangement that suits your needs, rather than having to allocate the loan 50:50, which is a common misconception about split loans.
You also want to think about the length of your fixed rate loan. Given the security of this type of loan, you will need to be conscious that you may have to pay more interest the longer a loan is fixed for. Generally, the duration of a fixed rate loan is one to five years, with the maximum term being ten years. After this period, either you move onto a variable rate or will need to refix at a new rate (if this is allowed by your lender).
Tips to prepare for a rate rise
Know your finances: By having a solid grasp of your earnings and expenditure, you will be better placed to work out how much higher your repayments are likely to be when rates rise.
Create or update your budget: Following on from this, an up-to-date budget is crucial to keeping on top of your finances.
Know your loan terms and conditions: If it has been a while since you familiarised yourself with the ins and outs of your loan, make sure you understand what these are. There might be additional costs and conditions that you aren’t aware of, or which no longer suit your situation so aren’t needed.
Watch your spending: You don’t have to tighten the purse strings necessarily, but it is wise to cut back on what you can – always a smart move, but especially so during times of rate rises.
With all the news of impending rate rises, it can be an anxious time for many home owners, as well as confusing. Now is a great time to speak with us about your current loan and to look into whether it still suits both your current and future needs.
We can help you select an option to best support your financial goals, which may be fixing your home loan, or looking at other possibilities now or into the future.
ii https://www.canstar.com.au/home-loans/prepare-rate-rise/
iii https://www.smh.com.au/property/news/should-you-fix-your-home-loan-now-20220311-p5a3yo.html
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