Home loan interest rates – to fix or not to fix?
At the June Reserve Bank meeting the decision was made to increase the cash rate, by 0.50% to 0.85%.
The big four banks have all announced they will be passing on this 0.50% hike to their new and existing home loan customers.
How much could rate rises cost?
Major bank fixed rates show borrowers who locked in for two years in mid-2020 would likely be paying an average rate of 2.27%. For those with a $500,000 loan, this would mean monthly repayments of $1,916.
If they were to roll off their fixed term in July 2022, at which point the average variable rate among the majors is expected to reach 2.89%, their monthly repayments would increase by $153 to $2,069.
But it will be a bigger jolt for homeowners with a $500,000 loan who locked in the average two-year fixed rate of 2.10% in January 2021 with monthly repayments of $1,873.
If they roll off in January 2023, when the average variable rate is expected to reach 3.89%, they’ll be facing a whopping $452 extra per month.
Borrowers who locked in for three years at the start of 2020 would be paying an average rate of 2.98% and for a $500,000 loan, with monthly repayments at $2,103.
Assuming the average big bank variable rate rises to 3.89% by early 2023, this same borrower would see their monthly repayments rise by $231 to $2,334.
A borrower with a $500,000 mortgage who locked in back then could pocket savings of up to $223 each month when their fixed rate expires; assuming the average variable rate among the major banks reaches 2.89% by mid-2022.
What to do about rising interest rates?
Refinancing to a lower rate loan means seeing how your loan stacks up against the broader market and if there’s a better deal, switching to a new lender.
Reserve Bank figures show in February, the average variable rate on outstanding loans was 2.92%, which is 0.43% higher than the average of 2.49% across new loans written in the month.
But homeowners with fewer than 20% equity who are looking to refinance may not get the best rates as it only applies if you borrow between 60% to 80% of your home’s market value.
Another choice that can be explored is, splitting your loan between fixed and variable.
For example, you might decide to fix 60% of your loan, while leaving the remaining 40% variable.
This can provide shelter from rate rises, while allowing you to benefit from the flexibility of a variable rate, however if variable rates fall, you won’t pocket the full savings on the fixed portion of your loan.
Fixed home loan interest rates
Fixed home loan interest rates could be termed predictive. That is, lenders look at the cost of holding money at a certain rate for a certain amount of time and determine the interest rate accordingly.
In general, if a lender expects the cash rate to rise, the fixed rate will usually be higher than the variable rate; on the other hand, if the expectation is for the cash rate to fall, the fixed rate will tend to be lower than the current variable rate.
When a borrower fixes the interest rate on their home loan, they are usually anticipating that the variable rate will rise above the rates which they have locked in.
Lenders may offer fixed terms between 1 and 10 years; however, most fixed rate terms are between one and five years.
Once a borrower has locked in their fixed rate, they will start paying the fixed interest rate straight away.
For example, if a borrower fixed their loan today at a five-year fixed rate which is 2% higher than the variable rate, the borrower would start paying an extra 2% interest right away.
Pros and cons of fixed rates
A fixed rate loan is a loan that has a fixed interest rate and therefore fixed loan repayments.
The period of these loans can vary, but you can usually “lock in” your repayments for between 1-5 years. Although the fixed rate period may be 3 years, the total length of the loan itself may be 25 or 30 years. At the end of the fixed loan period, you can decide whether to fix the loan again for another period of time at the current market rates or convert the loan to a variable interest rate for the remaining time left of the loan.
- Repayments do not rise if the official interest rate rises
- Provides peace of mind for borrowers concerned about rate rises
- Allows more precise budgeting
- Repayments do not fall if rates fall
- Allows only limited additional payments
- Penalises early payout of the loan
Want to know more about how the recent interest rate increases impact your situation? Get in touch the team at Provide Finance today.