Rate rise jitters: what to do about them
As we enter the countdown to August 8, many home-loan borrowers are sweating on whether the Reserve Bank of Australia (RBA) will leave interest rates on hold or increase them. The popular press is backing the latter and this is causing ripples of angst across the mortgage belt, particularly among first-time borrowers or investors.
Act now or chill out and see what happens? Based on historical data, when the RBA announced the cash rate increase of 25basis points from 6% to 6.25% back in Nov-06, banks followed suit. There is a close relationship between the cash rate and the fixed and variable rate loans offered by the lending institutions but does this mean you should be rushing to your bank to lock interest rates or should you take a step back and review your options? A cool-headed approach works every time so take time out to review your situation and how a rate rise might affect it.
Three Things to consider
Are you entering the home loan market for the first time? If you are a home loan novice, the most important thing you need to decide is whether a fixed or a variable rate would suit you. On the one hand it's possible to gain some control and certainty about future repayments if you fix (before the rate goes up) but the downside is that you may miss out on reduced repayments, if interest rates fall. With variable loans, as opposed to fixed-rate loans, you have the flexibility of making excess payments as well. To many, the answer is to split the loan and enjoy the benefits of both a fixed and variable mortgage. That way you will reap the benefits whether rates go up or down in the future.
Refinancing?
Have you been toying with the idea of refinancing? You may be upgrading or are just not happy with your current lender? Maybe you feel there are better offers in the market. Be aware that refinancing in haste might cost you more than you bargained for? Ask yourself these key questions.
What is the exit penalty and how long do I have to stay with my current lender to avoid it? If I do incur an exit penalty, how many years do I have to stay with the new lender to make up for this extra fee? Your new lender may offer a lower interest rate, but calculate how much you would really save after all fees are considered and whether it is worth switching? Would it be better to switch to another product with the same lender? The change in cash rates (if any) will prompt banks to revise and re-price their products. You may be better off waiting and watching to see how the different market participants change their product offerings before determining which one would work best for you.
Conservatism pays! Set aside the "she'll be right" attitude because there's no better time than right now to revisit your budget. With an increase in prices of petrol and food, coupled with the uncertainty of an interest rate rise, there is no doubt it will affect disposable incomes and the way we spend our extra dollars (if any). It would be wise to look at our monthly budget and identify areas where unnecessary expenditure could be curtailed in order to manage a rate rise on your mortgage. The following table gives some indication of the extra dollars you would have to find in the event of a rate rise.
| Increase in Monthly payments * | |||||
|---|---|---|---|---|---|
| Loan Amount | $250,000 | $275,000 | $300,000 | $325,000 | $350,000 |
| Initial Monthly payments | $1,841 | $2,025 | $2,209 | $2,393 | $2,577 |
| Payments after rate increase | $1,882 | $2,070 | $2,258 | $2,446 | $2,634 |
| Difference per month | $41 | $45 | $49 | $53 | $57 |
| Source: CANNEX 01/08/07 | |||||
Kiss your mortgage goodbye For most home owners, making the last payment on their mortgage is the fulfillment of a long life dream and a great cause for celebration. If your single goal is to pay off your home loan as soon as you possibly can, why not do something about it? By just putting a few extra dollars toward the mortgage every month and getting used to slightly higher repayments, you could be mortgage-free in less time. For instance, on a variable mortgage of 250K at 7.5% over 25 years, monthly repayments are around $1847.If you can pay an extra $80 per month (or $20 a week), you could reduce the life of the loan by more than two and a half years. That's a small price to pay for such a huge saving.
| Extra Loan Repayments | ||||
|---|---|---|---|---|
| Loan Amount | 250K | |||
| Interest Rate | 7.50% | |||
| Extra payments per month | 0 | $80 | $120 | $160 |
| Interest saved over the life of the loan | 0 | $39,428.71 | $55,097.77 | $68,814.02 |
| Time saved | 0 | 2yrs 8 months | 3yrs 10months | 4yrs 10months |
| Source: CANNEX 01/08/07 | ||||
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