The latest June 2022 interest rate increases may not have come as a surprise, but that doesn’t mean many homeowners won’t feel the effects over the next few weeks.
Let’s look at what is happening in simple terms, what this means for homeowners and buyers, and what options might be available if you feel the pinch.
What Determines The Interest Rate in Australia
When we talk about interest rates in the context of loans, there are two main things to consider:
- The cash rate, which is set by the Reserve Bank of Australia (RBA), and,
- Home loan interest rates, set by the lenders and banks themselves.
How Are Interest Rates Determined?
The cash rate set by the RBA is influenced by several economic factors and can be changed by the RBA to influence monetary policy in Australia.
The RBA usually reviews the cash rate on the first Tuesday of each month, excluding January, and it is often changed in increments of 0.25% (a quarter of a percent). However, changes to the rate can be smaller or larger than this, or the rate can be reviewed outside of this regular cycle if the RBA deems it necessary.
While the rate set by lenders is heavily influenced by the cash rate set by the RBA, other factors are at play, including the cost of funding, expected profits, and the rate at which the RBA funds can exchange funds between banks in the wholesale market.
Due to these factors, there is a difference between the RBA Cash Rate and the interest rate you are likely to be paying on your home loan.
Why Are Interest Rates Going Up So Fast?
In November 2020, at the height of the Covid pandemic, the cash rate set by the RBA plummeted to a record low of 0.10%. It stayed there until May 2022, when the RBA announced a 0.25% (a quarter of a per cent) increase to 0.35%.
At its June meeting, the RBA announced a further rise of 0.5% (half a per cent) to curb the rapidly increasing inflation rate in Australia, taking the cash rate to 0.85%.
Many lenders have already announced that they will pass on the total increase of 0.5% to any customers with variable-rate loans. Others are expected to follow suit, meaning that most homeowners will now pay an extra half a per cent on their current interest rate.
Will Interest Rates in Australia Continue To Rise?
Unfortunately, this is likely to be only one of a series of rate rises. Economists are forecasting further rate rises throughout 2022 and into 2023, depending on economic conditions.
Since rates have been at record lows for quite some time, it was always very likely that they would eventually need to move up by a significant amount.
On an average $600,000 loan, a 1% rate increase equates to around $500 in extra repayments per month.
Will People in Australia Lose Their Homes Due to Rising Interest Rates?
As a safeguard against rising interest rates causing widespread unaffordability, lenders apply an ‘assessment rate’ when deciding whether to approve a new loan application.
For example, if you apply for a loan with an actual rate of 3%, lenders must add at least an additional 3% on top of the actual rate to ensure you can still afford to meet your repayments if rates increase by this amount.
In this example of a 3% interest rate, lenders must assess that you can continue to afford your repayments if the interest rate on your loan increases to 6%. (The assessment rate was commonly 2.5% above the actual rate until an APRA directive in November 2021 standardised it to 3%.)
This buffer is designed to ensure most homeowners can weather a significant number of rate rises and still be able to manage their repayments with careful budgeting.
However, suppose you do find yourself in financial hardship. In this case, it is crucial to talk to your broker or lender as soon as possible as there may be several options available for you to consider.
Is Everybody Worse Off when Interest Rates Rise?
It’s important to note that while borrowers are usually worse off when interest rates rise, rising interest rates also mean a higher rate of interest is paid on savings. This means that many self-funded retirees (SMSF holders) and several other types of investors may benefit from higher interest rates.
How Will Australian Interest Rate Increases Affect My Home Loan Repayments?
If you have a variable rate loan, chances are your interest rate is about to go up.
If interest rates do go up, your home loan repayments will need to increase to ensure you pay off your loan within the agreed term (usually 30 years).
If your lender automatically direct debits your payments, this increase will happen automatically.
Still, you’ll need to ensure you have sufficient extra funds in your account to cover the increased repayment amount.
If you manually initiate payments to your home loan, you will need to increase your repayment amount manually, so your loan doesn’t fall into arrears.
In either case, your broker or lender can tell you what your new repayment amount will be, or you can also usually find this information in your internet banking app.
If your loan is fixed, your repayments will not change during the fixed-rate period (usually 1 to 5 years, depending on what you have agreed with your lender) regardless of rate increases or decreases.
However, it is important to be aware that in a rising rate market, your interest rate and repayment amount may increase very sharply once your fixed-rate period ends.
Is It Too Late To Fix My Home Loan In Australia?
When rates begin to rise, many borrowers rush to fix all or part of their home loan rate to protect against any further increases. Fixing your home loan interest rate can be a good option in some cases, but it is not a one-size-fits-all solution.
If you consider fixing your home loan, here are a few things to keep in mind.
1. Fixed Rates Have Already Increased Dramatically Over the Past 6 Months.
Lenders constantly monitor economic conditions to forecast their long-term rates. If they expect rates to increase over time, they will set fixed rates that reflect this likely increase, even before it happens.
At the height of the pandemic and resulting economic uncertainty, some lenders were offering 4-year fixed loans at under 2%. However, since late 2021, fixed rates have slowly been creeping up. Today – as of Wednesday 8 June 2022 – the lowest 4-year fixed rates from our panel of lenders sit around the high 4% mark.
The cheapest fixed terms are currently 1-year fixed loans, the majority of which now fall within the high 2% to mid 3% range.
You can expect to pay a higher interest rate the longer you choose to fix your loan.
For comparison, owner-occupied variable rate loans currently start at 2.14%pa (comparison rate 2.18%).
For an up-to-date overview of the current rates on offer, visit our Facebook page at facebook.com/NBSHomeLoans
2. Fixed-Rate Loans Are Generally Less Flexible Than Variable Rate Loans.
There are restrictions on making extra loan repayments, accessing redraw or offset options, or switching your loan type with most fixed-rate loans.
You will also be up for hefty break costs if you decide to payout or close your loan during the fixed-rate period or sell your property; these can run into tens of thousands of dollars depending on the loan size and remaining term. You also don’t get the benefit of any rate reductions should these occur in future.
Before deciding, it’s good to chat with your broker to ensure that fixing your loan is an appropriate course of action for your individual circumstances.
Can You Extend A Fixed Loan?
If your loan is already fixed and your fixed term is due to expire, you may be wondering what your options are.
Once a fixed loan term ends, your loan will automatically revert to your lender’s current standard variable rate unless you speak with your broker or lender before the fixed loan expiry date to make other arrangements.
It’s important to be aware that in a rising rate market, your interest rate and repayment amount may increase very sharply once your fixed-rate period ends.
You can not extend your current fixed loan period once it expires, but you can choose to fix it again for a further period. The lender’s current interest rate for your chosen fixed loan period will apply, which may be higher than you are currently paying.
How Will Interest Rate Rises in Australia Affect Me If I Am Trying To Buy A Home?
If you have already checked your borrowing capacity or obtained a pre-approval with your broker or lender, you must revisit this.
When rates increase, your borrowing capacity drops, so your initial maximum budget may now be less than what you have been initially quoted.
For example, yesterday’s rate increase reduced most of our clients’ maximum budgets by around 10%. As a result, house prices will likely be affected by this change. However, this may not be immediately reflected.
How Will Interest Rate Rises in Australia Affect Me If I Am Trying To Build A House?
If you have already purchased land and plan to build a home, you should speak with your broker or lender urgently. Your maximum construction budget is likely to be negatively affected by these changes.
Rising construction costs further compound this, so it’s vital to discuss your options early in this situation.
Of course, if you have a lot of cash behind and are not at the top of your borrowing capacity, you are likely to be more cushioned against the effect of recent and future rate rises.
What Can I Do If I’m Concerned About Rising Rates in Australia?
While fixed rates have increased significantly over the past 6 months, fixing your rate is still an option that may suit some borrowers. It is important to speak to your broker about this option before deciding, as we can help you weigh up the pros and cons in your specific situation.
If you decide to leave your loan on a variable rate, it’s important to prepare for future rate rises.
As fixed rates are currently significantly higher than variable rates, a great piece of advice is to treat your loan as though it is fixed at the higher rate and make repayments at the higher rate starting right away. Then, if interest rates do rise to the amount you are already paying, you should have built up a significant buffer and will be ahead on your loan.
NBS Home Loans can help you calculate your repayments on a range of fixed terms so you can allocate these funds towards extra repayments.
It’s also helpful to utilise features such as an offset account if your loan comes with one, as any funds in the account will help to reduce the overall amount of interest you pay.
How Do You Deal With Higher Interest Rates?
In either case, it’s essential to review your loan to make sure it’s still the right fit for you, so chat to your broker sooner rather than later to see if there are any better deals you may be missing out on.
In this sort of market, experience really counts.
It’s crucial that your finance broker thoroughly understands, and has extensive personal and professional experience through a range of interest rate cycles and economic conditions, so they are well placed to help you navigate your options.
With hundreds of loans from over 40 lenders and over 20 years of experience, NBS Home Loans take the hard work out of comparing loans to make sure you aren’t leaving any money on the table by missing out on other options.
Contact us today on 0434 103 326 to discuss your options for your personal situation.