In the post-GFC years, the cash rate was above the 7 per cent mark and while it would take quite some time for it to climb back to that level, over the life of a 30-year mortgage it could definitely happen.
This is why the Australian Prudential Regulation Authority has advised lenders to use the 7 per cent interest benchmark to determine serviceability for all mortgages. All new borrower applications should be subject to whether or not the bank determines that a mortgage could be comfortably repaid at this higher rate.
While this has been APRA’s recommendation for some time – and has already been adopted by many lenders – there has been reports of questionable lending practices throughout the banking industry in recent years that have led the bank to make the recommendations official.
As a borrower, it’s good practice to make sure you would be able to pay back your loan at a 7 per cent interest rate. To find out how, see below.
Use a mortgage calculator
The first thing to do to check if you would be able to afford your mortgage at a higher interest rate is to use the RateCity mortgage calculator. This will allow you to see what your repayments will be like at a higher rate. Once you determine the size of your monthly repayments at 7 per cent interest, do some calculations to see if this is no more than 30 per cent of your take home income. If it is over 30 per cent than paying your loan off at this rate would place you in mortgage stress – a level of debt that may have a negative impact on your quality of living.
Pay off as much as you can now
If you do realise that an interest rate rise could have a dramatic negative impact on your finances, then it’s time to start taking advantage of how low rates are now. Paying off as much as you can comfortably afford each month while rates are low will shorten the life of your loan and lessen your chances of ever falling prey to much higher rates.
Stash an emergency fund
While you have a mortgage it is important to have an emergency fund that could cover your repayments should you come up against an unexpected roadblock in the future. While this is often taken to mean a loss of income, it could also include your rate rising and repayments becoming unmanageable. Having an emergency fund would give you time to refinance your loan to a lower rate or contact your lender and discuss your situation should this become the case.