After many months of record low rates, the Reserve Bank of Australia RBA began increasing interest rates this year.
In July 2022, RBA increased the cash rate target to 1.35% to dampen inflation pressures across the economy. As per news reports, financial markets expect the RBA to take the cash rate to 3.5% by mid-2023.
Like most borrowers, you, too, may wonder if locking in a fixed interest rate will safeguard you against multiple rate rises.
This article looks closely at factors that can help you make an informed decision if it’s time to fix your loan.
Why is My Lender Giving Me a Higher Interest Rate?
Firstly, banks determine your monthly mortgage repayment using different variables. These include RBA cash rate, funding costs, the competitive environment, and customer feedback.
Short-term finance costs are linked to the RBA cash rate. Following the RBA’s announcement to lift its key cash rate to 1.35%, Australia’s “big four” increased their home loan variable interest rates by 50 basis points (bps) per annum, passing on the central bank’s rate hike whole onto their customers.
On the other hand, banks don’t have a large pool of money from resources like customer deposits, for example, for longer-term fixed rates. They, therefore, access the wholesale market to get that money. The rates in these markets have been rising during global influences.
Listed below are the current variable rates and fixed interest rates being offered for owner-occupiers by the top four (as of 21 July 2022 on respective websites):
ANZ (LVR 80% or less)
- Standard variable home loan: Interest rate 4.24% p.a; Comparison rate: 4.24% p.a.
- Fixed-rate home loan (1 year): Interest rate 4.69% p.a; Comparison rate: 4.29% p.a.
CommBank
- Standard variable home loan: Interest rate 5.80% p.a; Comparison rate: 5.94% p.a.
- Fixed-rate home loan (1 year): Interest rate 5.14% p.a; Comparison rate: 5.88% p.a.
NAB
- Base variable rate home loan: Interest rate 4.70% p.a; Comparison rate: 4.74% p.a.
- Fixed-rate home loan (1 year): Interest rate 4.69% p.a; Comparison rate: 5.50% p.a.
Westpac
- Basic variable rate home loan: Interest rate 3.24% p.a; Comparison rate: 3.58% p.a.
- Fixed-rate home loan (1 year): Interest rate 4.69% p.a; Comparison rate: 4.93% p.a.
Click here for a closer perspective on how Australia’s top 4 banks profit from heftier mortgages during rate rises.
What Happens to My Home Loan If Interest Rates Continue to Rise?
According to RBA, a steady interest rate increase is preferable to wave off Australia’s rising inflation.
While speaking to the Australian Strategic Business Forum, RBA governor Philip Lowe, said that the central bank was looking for its “neutral rate,” which he later mentioned as “probably” 2.5%.
This indicates the likely increase of another 1.15% percentage points in addition to the recent rise to 1.35%.
Following the official cash rate hike announcement, RBA deputy governor Michelle Bullock made the following critical observations at a separate event.
- Per RBA estimates, home loan repayments for some mortgage holders would increase by up to $650 a month (or a 45% increase) once their fixed-rate loans expire around mid-2023.
- This is slightly higher than the rise in payments that variable interest rate borrowers would experience over this time.
- Up to 30% of mortgage holders may find it challenging to maintain their home loan repayments if interest rates rise three percentage points.
- With most of the low fixed-rate loans expiring within the next two years, nearly half of the borrowers entering the new variable rate market will face increases of at least 40% in their repayments.
On a positive note, however, RBA and economists believe Australia’s mortgage holders comprise about one-third of homeowners and are “well placed” to absorb the impacts of interest rate rises. The reasons include a significant drop in unemployment, wage growth and financial buffers built up during the pandemic.
Concerns about negative equity
The fall in house prices into 2024 is projected to be around 10-15%. Moreover, RBA estimates that even if there were a 20% drop in housing prices, the borrowers with negative equity loans would increase from 0.1% to 2.5%. This is still much lower than its 2019 peak of 3.25 %
Nonetheless, the reserve bank has cautioned that if you’re a first-home owner, a late entrant to the market and/or a low-income loan holder, you could be at a greater risk.
How Does Fixing My Home Loan Help?
Most economists agree that inflation and interest rates will rise this year. As a result, households should expect to pay higher living expenses, including mortgage repayments.
However, deciding to switch to fixed-rate home loans depends on your home loan objectives and financial situation. Assessing the pros and cons of fixing your home will help you plan.
Benefits of Fixing Home Loan
Avoids volatile interest rates:
Locking your interest rate for a fixed period will ensure predictable payments on fixed-rate home loans. Your interest rates will not change throughout the fixed period, which usually varies from 1-5 years.
Save interest in the long term:
Home loan borrowers will likely pay less interest on a fixed-rate loan over three years. Furthermore, some may prefer to play the long game with fixed-rate mortgages, potentially saving money once rates increase.
Ideal for borrowers with budget constraints:
If you feel that rates are rising faster than expected, you may not be able to pay your variable rate loan if it goes beyond a certain rate. For example, if your employment stability has changed, or your earnings have dropped since first taking out your loan. In such situations, taking out a fixed loan will be better.
Risks of Fixing Home Loan
Miss out on loan features:
Many prefer variable home loans because they offer access to features such as offset accounts or redraw facilities, which helps loan borrowers reduce their mortgage repayments.
Lacks flexibility:
A fixed-rate mortgage may be a bad idea if you want to sell your home mid-way through the loan term. Likewise, you may be unable to pay extra on top of your regular payments if you wish.
Furthermore, you’ll have to pay hefty break costs if you want to remortgage, make extra repayments or switch back to a variable interest rate.
Rolled on to a higher variable later:
Once your fixed-rate period ends, your lender may roll you onto the current standard variable rate, especially when rate hikes are imminent. Usually, it’s higher than the fixed rate locked in years ago.
Competitive variable rate home loans
Depending on the duration of the fixed term and home loan products, it’s pretty likely that you may find a more competitive variable home loan rate that may work cheaper in the short term.
Rate cut
Per the RBI announcement, inflation is expected to peak later this year and then drop in the 2%–3% range next year. Therefore if a rate cut does occur, as predicted, in late 2023 or 2024, borrowers on fixed rates may not benefit if the rate cut is passed on.
Costlier
By switching to a 4 or 5-year fixed rate, in such a scenario, you could potentially end up paying an even higher rate. This is because many lenders expect you to pay for the added security that comes with locking in a home loan rate for a longer term.
So, Should I Fix My Home Loan Now?
Ultimately your financial situation is the best indicator if it’s time to fix your loan.
The chief reason that home loan borrowers fix their home loans is to benefit from lower rates in case of a hike. In addition, fixed interest rates imply predictable payments; you can budget for your expenses and what you’re up for when you are locked in.
Nonetheless, the total interest you can save will depend on your current interest rate, your lender and the new interest rate offered. Over the past several months, there has been a consistent trend, with fixed interest rates rising across all lenders and terms.
Based on the pros and cons illustrated earlier in this article, fixing may not be a good move if:
- You would like to clear your debts as early as possible by making extra repayments on your home loan.
- You intend to sell your property during the loan term.
- You are keen on refinancing your home loan.
- Y would like to access the additional features that come with variable home loan rates.
To sum up, there’s no one fixed answer. The ideal way is to research all the available rates and features of loans in the market, including those of smaller lenders. Sometimes the smaller brands offer the best rate as they want the business.
Is a Variable Rate Home Loan Better?
Fixed rates are ideal when you want peace of mind and know your expenses in advance. However, they can be very restrictive too.
Conversely, though variable interest may increase the cost of your repayments in the event of a rate rise, you could avail the benefit whenever the rates fall, and your lender passes on the rate cut to you.
Moreover, variable rate home loans typically offer extra repayments, redraw facility, and offset. These features and benefits usually come at higher interest rates, but they offer better options for managing your home loan repayments, even in case of rate rises.
How Do I Fix my Home Loan?
In most cases, you could contact prospective lenders, who’ll fix your interest rate over the phone.
Alternatively, your lender may offer the option to fix your home loan. If eligible, you can opt to fix your interest rate and follow the simple steps to change your interest rate instantly.
What to Consider with a Fixed Rate Home Loan
Locking your home loan rate involves speculation and risks. Keep these few things in mind before you fix your rate :
Duration of the lock-in period
Typically you can maximise interest rate if you only lock in a fixed rate for three to five years. However, locking it for a shorter fixed rate term will usually not protect you from interest-rate hikes. Likewise, avoid exceeding five years. Over a more extended period, fixed rates may restrict the flexibility of your home loan.
Amount
Calculate how much you will likely pay off your home loan over the fixed rate term if you plan to make extra repayments and clear your debts faster. Then, keep that portion of your loan variable. You can make extra payments on your variable amount without any break fee penalties.
Home loan objectives
Review your home loan objectives if you plan to fix your variable loan. Prematurely winding your fixed-rate period typically incurs high exit fees or break fees. Unless you think switching to the fixed-rate period will outperform variable rates and be worth the benefits, it may be better to wait for your term to end and change your home-loan arrangement.
Likewise, since you may not be able to make large additional repayments, ask if your lender offers flexible fixed-rate options at the onset. In this way, you may be able to make extra repayments, limited to a set amount annually.
Additionally, fixing your fixed rate loan when you have plans to sell will only hurt your budget due to the high exit fee.
Revert rates
It’s unlikely that your lender will revert your loan to the bank’s lowest variable rate when the fixed-rate period ends. Instead, your lender will probably roll you onto their standard variable rate, which may be much higher than some of their lowest rates.
Alternative Options to Manage Rising Interest Rates
If the current interest rate projections bother you, now would be a good time to review your home loan. You may also want to consider alternatives to fixing your loan.
Refinancing
If it’s been some time since you last refinanced or obtained your loan, you may be in a more suitable financial position to consider refinancing. For example, your earnings and saving may have increased. Moreover, there may be newer and better deals that can help you save money.
Lender’s usually favour refinancers who have good credit scores as well as loan-to-value ratios of 80% or less. If you’ve increased equity in your home, you may be more likely to qualify for a home loan at a lower rate.
Refinancing to a variable loan may enable you to make extra repayments on your variable portion and access offset and redraw facilities.
An offset account with a lower interest rate may help reduce monthly repayments and offset the impact of an interest rate rise.
Split Rate Home Loan
You may also want to consider a split loan, where you split your loan into two loan accounts and then fix one of those accounts. As a result, you benefit from a cheaper variable while enabling the fixed component of your loan to protect you against future rate rises.
If you’re concerned about the rising rates and your capability to pay, you could consider refinancing. Read our blog on rising trends of refinancing in 2022 to see if refinancing may help you get a better loan deal. Alternatively, check out how our Live Auction mortgage marketplace can help you identify competitive rates when refinancing.
