Money Matters Monday 16 April 2018
Preparing for Interest Rate Rises
Last week Reserve Bank Governor Philip Lowe reminded everyone that the next move in interest rates will be up not down.
Retirees will welcome any slight relief after years of minimal returns on fixed deposits but some borrowers will receive a big shock.
Borrowings of all types – credit cards, personal loans and mortgages – have increased in recent years, but none more so than home loans. People could borrow more money to buy the same house and did so, pushing prices up.
It’s been more than seven years since interest rates last rose increasing home loan payments so many borrowers have never experienced a jump in the monthly payments necessary. Others who have, have forgotten the effect on the household budget.
The potential effect of an interest rate rise
If interest rates rise one per cent by the end of next year the payments on a $500,000 loan over 25 years will increase by about $300 per month. That could require serious cutbacks to other spending.
The RBA says around 30 per cent of all loans are interest-only. Many people have bought homes in recent years with loans where nothing is paid off the principal. After five years they revert to principal and interest, with payments jumping more than 40 per cent, or $900 on a $500,000 loan.
How to prepare for rate rises
That would mess up most people’s budget. Borrowers can prepare for the coming rate rises. One option is to lock in a fixed rate on the home loan now. Five-year fixed rate loans are still available at 4.5 to 5.0 per cent, little more than current variable rate loans.
Five years should take the loan past the peak in the next rate cycle to a time when interest rates are falling again. However, people should not to lock in a rate if they may want to sell the property before the term expires as large exit penalties will apply.
Another option is to start paying increased loan payments now to build up a buffer of payments in advance before rates rise. This reserve will help later if cashflow gets tight. Interest-only loans allow a limited amount of extra payments each year.
Those with interest-only loans could ask about moving to principal and interest early to start reducing the loan debt and interest charged when rates rise.
It may be possible for people with principal and interest loans to extend the loan term. This would reduce the payments necessary if people are already struggling with them.
Rate rises are not imminent and will be gradual. The date most commonly predicted by analysts for the first increase is November this year. After that rates are likely to creep up slowly. It is important to plan ahead to avoid getting caught out by unexpected payment demands.
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