How to prepare for rising home loan interest rates

With leading banks raising fixed rates and slashing variable rates, many borrowers may be reconsidering variable rate home loans. But with almost one in four new mortgages taking on unsafe debt levels, and banks forecasting that interest rates could start rising as soon as June 2022, what steps can you take to help minimise the risk of bill shock before the next rate rise?

What causes interest rates to rise? 

Interest rates can rise and fall based on a wide range of factors, from the cost of overseas funding for banks to the current state of the Australian economy. One significant factor to consider is the national cash rate, set by the Reserve Bank of Australia (RBA).

The cash rate is the interest rate at which banks charge one another for overnight cash loans, which they use to supply 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 may charge on loans as a result.

How could rising interest rates affect me?

A typical home loan repayment is made up of a small part of the remaining mortgage amount owing (the principal) and an interest charge. Over the course of the loan term (often 20 to 30 years), these principal and interest repayments 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 course of the loan term. If the RBA raises the national cash rate and your mortgage lender passes on this change as 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 repayments will remain the same, whether your lender raises or lowers its variable rates. Once the fixed term expires though, your loan will revert to the lender’s variable rate, which could have changed significantly.

Will a rate cut lower my home loan repayments?

Often no. Not every lender will automatically lower your monthly repayment when it cuts your interest rate – you may have to contact your lender and specifically request it if you’d prefer to pay less from month to month.

In many cases your lender will keep you on the same regular repayment amount by default, with a smaller percentage being made up of interest charges and a larger percentage going towards paying off your mortgage principal. While you may not save you money month to month, this can help you pay off your mortgage faster, so you can potentially save money on interest charges over the long term.

What can I do about rising rates?

When you apply for a home loan, mortgage lenders are obliged to check that you can not only afford the repayments today, but in the future if rates were to rise. That said, many Australians have never experienced an interest rate rise 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 you weather the storm of rising rates:

Make extra repayments today

If your home loan interest rates are currently on the low side, it may be a little bit easier to put some extra money towards your mortgage. This could be adding a little extra onto each monthly repayment, or paying a lump sum when you have extra cash available, such as a tax refund. Getting ahead on 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 puts any restrictions on extra repayments (fixed rate loans are often less flexible than variable rate loans), and if you’ll be able to access these extra repayments in the future if necessary using a redraw facility. Another option could be to put extra money into an offset account, which can help lower your interest charges while keeping your cash easy to access.

Refinance

If your lender’s interest rates are on the high side, you may have the option to switch and save with another bank or mortgage lender. Even when interest rates are rising, there are competitive home loan offers available from a variety of different mortgage lenders.

If you’ve previously been making extra repayments, you may have built up extra equity in your property. This can often help you qualify for more competitive mortgage deals when you refinance, whether you’re looking for lower interest rates, or features and benefits that better suit your financial situation.

Keep in mind that refinancing may not always be the best option for every home loan. For example, if you’re on a fixed interest rate, refinancing could mean paying significant break fees.

Contact an expert

If you’re concerned that interest rate rises will leave you in mortgage stress, you can contact your lender’s hardship team about other options that could 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 may better suit your budget and financial situation.

If things are looking dire, a financial counsellor may be able to help you find options to get your money back on track.  

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