How to prepare for an interest rate rise

It's not uncommon for the Reserve Bank of Australia to change the cash rate over a 25-30 year mortgage. And with interest rates currently on the rise, there are steps homeowners can take today to prepare their mortgage ahead of time.

As the interest rate is arguably the biggest ongoing cost that can influence a home loan, preparing your budget for a rate rise may be useful in reducing potential financial stress.

The RBA, the cash rate, your home loan, and your lender

Australia’s cash rate is an interest rate set by the Reserve Bank of Australia (RBA) that is charged on overnight loans for banks and other lenders. It also impacts the interest rates lenders charge their customers for home loans, as well as savings accounts and term deposits.

So, when the RBA hikes interest rates, what does this mean for your home loan in terms of real-world impacts?

Variable interest rates are the rate type that is typically affected by a cash rate hike. Put simply, if you’re on a variable rate home loan and your lender chooses to hike rates in line with the cash rate, then your interest rate – and therefore your monthly mortgage repayments – will increase.

But fixed rate customers aren’t out of the woods yet. If you’re currently on a fixed rate home loan, your interest rate will not change for the fixed term duration you have agreed to. However, once this fixed term ends, you may find that your home loan reverts to the lenders’ standard variable rate. This may be higher than your current fixed rate, and your mortgage repayments may increase too.

How to prepare your current home loan for a rate rise

If you’re currently repaying your mortgage, there are a few options you may want to consider if you’re hoping to lessen the impact of a rate hike on your budget.

Extra repayments

If your lender allows for extra repayments without penalty, then acting now to chip away at your loan principal with additional payments may be worth considering. The more you can reduce your principal owing, the more you may be able to reduce your monthly mortgage repayments.

Offset account

If your lender provides an offset account, it may also be worth considering utilising this home loan feature.

This is a linked transaction account to your home loan. Unlike extra repayments which chip away at your principal, the funds you deposit in your offset account work to ‘offset’ or reduce the amount you pay in interest. Plus, you have the added bonus of being able to potentially withdraw these funds if needed, such as for a home renovation.

On average, homeowners using their offset accounts may be four years ahead on their repayments, according to the latest APRA data. RateCity research found that this same homeowner with a $750,000 mortgage with this average amount of $100,000 in their offset account may save over $16,000 in interest over five years.

Consider refinancing

If your lender hikes your interest rate past a point that you can comfortably service, and you’ve been repaying your mortgage for several years with some equity built up, it may be worth researching lower-rate lenders. Refinancing to a lower-rate home loan may be one option to give yourself a rate cut in a time of increasing interest rates.

RateCity research shows that if a homeowner with a $500,000 mortgage and 25-years remaining refinanced, they may be able to save hundreds in annual interest repayments.

If this homeowner switched from the RBA’s current average existing customer interest rate of 6.18% to the lowest ongoing variable rate on our database of 5.45% (paying principal and interest, excluding specials), they may save:

1. $221 in repayments in the first month, and
2. $2,652 in interest in the first year (assuming no other rate changes occur - does not include fees).

Out-of-cycle rate hikes even without a cash rate move

While lenders are encouraged to follow the rhythm of the RBA cash rate, they still have the final say on their interest rates.

In fact, RateCity research found that the average of the big four banks’ lowest fixed rates increased between 0.35% - 1.31% in 2021 – despite no cash rate hike that year.

It’s important that homeowners keep an eye on their interest rates and on the news, so they’re not shocked to find their ongoing mortgage repayments are suddenly more expensive.

If you’re unhappy with your lender for hiking its interest rates out-of-cycle, it may be worth calling up your lender and requesting a rate decrease. If they won’t budge, you could always consider researching whether refinancing to a lower rate lender may better suit your budget and goals.

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