Why you should listen to your gut first, then your lender

Using a home loan calculator will help you find out how much you’ll pay on your mortgage over the years. But have you considered what would happen if interest rates soared?

The nation’s official cash rate, which is set by the Reserve Bank of Australia (RBA), is currently 2.5 percent.

A low cash rate is favourable for those looking to take out home loans, given that it allows lenders to offer more competitive rates but while banks are willing to lend you the money now, while the rates are low, have you considered how your circumstances would change if rates rose? The current low rate has been stable since August 2013, making the one question on everyone’s lips: “When will it rise and how will that affect me?”

How long will low interest rates be around?

Glenn Stevens, Governor for the RBA offered a positive answer in the most recent monetary policy decision:

“In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.”

While this is good news for those seeking home loans in the near future, the official cash rate will probably lift at some point. Existing homeowners paying off their mortgage as well as those entering the real estate game in months and years to come will need to grapple with the idea of higher interest rates — meaning greater repayments.

Making a financial commitment that lasts for decades

For most Australians, buying a property is the single largest financial commitment they’ll make in their lifetime. 

It’s essential to utilise tools like home loan calculators and budget spreadsheets in order to establish the true cost of home ownership. Initial one-off costs, regular loan repayments and ongoing maintenance and repair costs can quickly mount. That’s not to say owning a home isn’t a smart move — it just requires a high level of pre-planning before diving in head first. 

That said, some individuals are stepping onto the property ladder without adequate financial backing, with some lenders being accused of offering risky home loans, according to consumer advocate site CHOICE. Low-deposit or no-deposit loans are being offered, as well as mortgages that require family members to step up as guarantors.

Lenders Mortgage Insurance (LMI) is usually required if you borrow over 80 percent of your home’s value so if your deposit is less than 20 percent of your desired property’s value, you’ll have to account for this extra cost.

However, LMI won’t rescue homeowners who can’t honour their mortgage repayments — it’s simply protection for the lender.

Could you afford higher repayments?

Of course, not all borrowers go beyond their means when taking out a home loan. However, it’s imperative to look into the future.

If the official cash rate was to soar in the future, those on variable-rate loans need to be sure they can absorb increased repayment costs without detrimentally affecting their savings accounts or retirement savings.

According to the Bankers Association, the average standard variable home loan interest rate (SVR) between January and March 1990 was a whopping 17 percent. This is the highest SVR between 1990 and 2012.

If someone was to take out a home loan at this rate today on a $300,000 property over a 25 year term, they would pay $4,313 per month and pay $1.29 million in total, including principal and interest.

That is over double what most home borrowers are currently paying in this low rate market. At a 7 percent interest rate, a borrower would pay $2,120 per month, paying $636,100 in total, including principal and interest.

So, ask yourself: If interest rates were to soar dramatically, could you foot the bill?

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