Interest rates are on the move

There has been a dramatic change in the lending market in the past two months. Since the middle of October, we have seen 3-year fixed rates increase as much as 90 basis points (bps) – equivalent to 0.9% p.a. – with most 2-year fixed rates increasing by 60 to 65 bps.

This change does not immediately impact existing borrowers. Variable rates have not yet been affected, and those with loans currently on fixed rates will not see an impact until their current fixed rate expires, which may be two or more years away in many cases.

But for new borrowers who are seeking a 3-year fixed rate home loan, their loan repayments are now 14% higher than they would have been two months ago. To put this into perspective, a family with a $500,000 home loan will see their repayments increase by $258 per month over 30 years.  Notionally, that is an additional $92,000 in total loan repayments over the term of a 30 year loan.

Why is this happening?

Banks are getting prepared for market lending variable rate increases coming forward. While the RBA maintains it will not raise the cash rate until mid-2023, banks and money markets are looking at other factors, such as inflation increasing overseas, and locally, and increases in interest rates overseas.

Whilst our rates remain low, money markets look for higher yielding deposits outside Australia driving our dollar down, which will increase the cost of imports, feeding into local inflation and ultimately bringing forward the need for the RBA to raise the cash rate.

Economist forecasts are varying widely – some are seeing an RBA rate move as early as May next year, while others maintain that the RBA can hold off until early 2023.

What are the likely impacts?

  • Reduced demand in the property market: Prospective property buyers react to increasing rates by delaying or re-evaluating their purchasing decisions. This causes reduced demand in the property market, which we are already observing.

  • Variable rates falling in the short-term: With fixed rates on the rise, lenders have switched their competitive focus to variable rates. Variable rates are actually falling as this competition heats up, but this is unlikely to last.

  • Increased variable rates in the future: Fixed rates are a leading indicator – a sign of the direction variable rates are likely to be heading. So, we should expect variable interest rates to increase in the medium term.

What can you do about it?

  • Prepare for increasing loan repayments: This may happen when your fixed rate expires, or as variable rates increase as early as next year.

  • Take every opportunity to reduce your loan balance: Use regular savings and/or lump sum reductions to decrease your loan balance before the rate increases affect you. 

  • Restructure your household budget: Why not start managing your cash flow as if interest rates are already at 3.5 to 4% pa? While rates remain low, you will be repaying more principal and attenuating the impact of rate increases by the time they roll around.  I liken it to increasing your cash flow fitness.

  • Re-negotiate your variable rate or discount with your lender: With competition having moved to variable rates it is now an excellent time to review your lending discount.

  • Review your plans to purchase: If you are in the market to purchase, review your plans and make sure you’re comfortable with repayments if interest rates increase to 5% p.a.

  • Apply a rate lock: If you are currently purchasing - apply a rate lock!  If you do not do so, you must accept the rate prevailing on the day of settlement.  With rates on an upward trend, it is best practice to pay the guarantee fee to lock in the rate quoted to you at the date of application.

“A real-life example of this:  David and Sue* paid a rate lock fee of $1,100 in October. This decision will save them at least $521.75 per month in loan repayments over 3 years, a saving of $18,783.”

*Names have been changed.

Is it too late to fix your loan?

It’s never too late to fix your home loan. While the days of super low rates appear to be behind us, the reasons for fixing remain the same.  Fixed rates are not a mechanism to out-guess the lending market – they are a valid risk management strategy for borrowers looking to build certainty into their household budget while accepting that they will forgo a degree of flexibility in the management of their loan.

The market has changed.  Borrowers need to expect and be prepared to manage increases in their home loan repayments. According to the chief economist at the Bank of Queensland, Peter Munckton, the question is not when, but by how much interest rates will increase over the next rate cycle.  Increasing rates are confirmation that the economy is doing well.  We should all welcome this, but borrowers need to be prepared for the demands it will place on their budgets.

References

Munckton, P. (2021) Interest Rate Update: Be Careful For What You Wish. BOQ.

Taylor, D. (2021) Will interest rates start rising with inflation and sink house prices and indebted home owners? ABC News.

Foster, S. (2021). Buckle up: RBA set to raise interest rates within months. Realestate.com.au

Murphy, J. (2021). Banks raising fixed mortgages despite RBA not lifting interest rates. News.com.au

Taylor, D. (2021). How the falling Australian dollar could affect interest rates. ABC News.

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