How to prepare for the impending rate increases?

Are you refinancing your home or property investment loans and worried about impending rate increases?

As you all would’ve no doubt read by now, there is a commentary and even assertions coming from the governor of the RBA, that we are likely to see multiple rate increases over the coming 12-24 months. This poses some questions that should be at the front of all our minds as we consider property investment and mortgage finance.

• Is my current mortgage structured correctly to maximize deductibility?
• Am I paying more than I need to?
• Am I ready for the increase in repayments that will come?
• Are there other options?

The answer to the above questions will change from reader to reader but the overarching theme of it is if you are paying more than you need to know, how much more will you be paying when the rates go up? Right now, we are seeing some lenders hungry for more business and this is evident through incredibly low-interest rates (starting from 2.09%) and very incentivising cash-back amounts (sometimes up to $6,000!).

For a point of reference, if you have a $1m mortgage and currently you are paying 3%, your repayments are likely to be at least $4,216.04 per month. If rates increase 4 times (or by 1%) and your rate goes to 4%, those repayments will go to $4,774.15, or in other words, increase by $558.11 per month!

But what if I told you, that we have a lender that will pay you $4,000, and start your variable rate at 2.09% for an Owner-Occupied loan? With rates starting around the 2.4% mark for Investment loans, now is the time to make sure you are starting the uphill slog at the lowest possible rate.

Many of our clients also need to consider what happens when their fixed rate period ends.

What should I do when my fixed rate ends?

Fixed interest terms on home loans don’t last forever, so it’s inevitable that you’ll have to decide what to do when yours ends. Do you want to opt for another fixed term? Switch to a variable interest rate? How about a split-rate home loan? If your fixed term is ending soon, now is the time to review your home loan, and look for a better deal.

If you don’t do anything nearing the end of your fixed term, your home loan will usually revert to your lender’s standard variable rate. Variable rates after the fixed rate ends tend to be much higher than usual. This is because lenders know that some people won’t be bothered to switch lenders at this point meaning that you end up paying a loyalty tax.

At this point you can sit on this rate for however long you like, but you may be able to get a more competitive interest rate if you look into your lender’s other options or refinance with a new bank.

Your lender will usually allow you to refix your home loan, but you want to make sure that you’ll be locking in a competitive interest rate. If you’d like some interest rate stability but don’t like the idea of locking yourself into a rate for years, you could pick a 1-to-2-year fixed rate or even consider a split loan.

Alternatively, finding a low variable interest rate could be beneficial. Variable-rate mortgages come with a lot of flexible advantages, including loan features and unlimited extra repayments.

Can you extend a fixed-rate mortgage?

You are unlikely to be able to extend a fixed-rate mortgage at its current set interest rate. However, you can definitely fix your home loan again at an up-to-date rate. While it’s typical to have a fixed rate period of 1-5 years, some lenders offer terms of up to 10 years for those who just prefer to set their home loan rate and not worry about it. The main risk of having a long-fixed term is that you could miss out on interest rate cuts if the cash rate drops during your term. But, if interest rates rise, you’ll be protected from increases until your fixed term is over.

Another thing to remember is that fixing your interest rate isn’t a great idea if you plan to sell or renovate your home using equity from the property within the fixed period. Fixed-rate mortgages also come with a lot of restrictions, meaning that you often can’t make unlimited extra repayments or utilise loan features like an offset account.

What is the penalty for breaking a fixed-rate home loan?

If you don’t want to wait until your fixed term expires before you refinance or overpay on your home loan, you are likely to incur break costs. Break costs are charged by lenders when borrowers do something to ‘break’ their fixed rate loan terms, for example:

• Refinancing/switching to a new home loan or lender
• Paying off your home loan early
• Making extra repayments that exceed any caps set by your lender
• Selling your home during the fixed period (without loan portability)

Exactly how much you are charged will depend on your lender, loan amount and the state of the market. Typically break costs are calculated based on:

• The amount of time left in the fixed term
• The difference between the lender’s cost of funds now versus when the loan was initially settled
• If you’re thinking about breaking your fixed-rate home loan, speak to your lender about how much you could be charged in break fees to see if it will be worth it.

If you have a variable-rate home loan, you won’t be charged break fees for doing these things. Try to plan and think of what interest rate type would best suit your circumstances, or even consider a split-rate mortgage.

Switching to a variable interest rate after your fixed term ends

After your fixed period ends, you should have a good idea of how fixed-rate mortgages work and whether you would be happy proceeding with an additional fixed term. If you found your fixed-rate home loan a bit constricting or you’d like to try something different, you could look into switching to a variable-rate mortgage.

A variable-rate mortgage will usually come with a lower interest rate, but this interest rate can and will fluctuate depending on the RBA cash rate and your lender’s financial situation. Some other features of a variable mortgage can include:

• Access to more loan features such as offset accounts, redraw facilities and loan portability
• Ability to make uncapped additional repayments
• When the cash rate drops, your interest rate will likely also decrease (and vice versa)
• Easier refinancing

Luckily, there are no penalties associated with refinancing from a variable rate. So, if you end up missing your fixed-rate stability, you can switch back with little hassle. Alternatively, a split-rate home loan is another option.

A split loan means that one portion of your loan balance has a fixed interest rate, while the other is on a variable interest rate. This way, you get the best of both worlds, and the split doesn’t even have to be 50:50.

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