It’s difficult to predict, or prepare for, an interest rate increase but understanding the how the Australian mortgage market works will certainly help you in your preparation. When budgeting for a home loan, interest rate basis points should always be factored in so you are prepared in the event of a rate rise.
What is a basis point?
A basis point is a unit of measurement used to describe differences in interest rates. It represents one hundredth of one percent or 0.01 percent.
For example, if the Reserve Bank of Australia raises interest rates by 25 basis points, it means that the cash rate has increased by 0.25 percent. So if the official cash rate is 4.75 percent and the RBA raises it by 25 basis points, the new cash rate would be 5 percent.
In the mortgage market, even a minor basis point movement to the cash rate can have a significant impact on the cost of your home loan. For instance, if you have a $300,000 home loan with an interest rate of 7 percent and the rate increases by 25 basis points to 7.25 percent, then your monthly mortgage repayments may increase by about $50.
Preparing for a rate rise
If you’re in the market for a home loan, whether it is your first mortgage or if you’re refinancing, then it’s a good idea to create a budget before you sign up for your loan. In this budget give yourself a rate rise buffer of 2 percent, or 200 basis points.
That’s because if rates rise by this much you’ll know that you’ll still be able to service the loan and live comfortably. If not, then you may face mortgage stress so you’d be wise to consider borrowing a smaller amount.
Otherwise compare home loans online at RateCity for a cheaper deal with a smaller interest rate, which can also save you significantly over the life of your loan. It may also mean you’re able to borrow a slightly higher amount, but this will also depend on a number of other factors including loan-to-value ratio.
Let’s use the example from above – a $300,000 mortgage with a rate of 7 percent that increases to 7.25 percent. If you were to compare mortgages and select or switch to a better home loan with a rate of just 6.59 percent you could potentially reduce your monthly repayment by around $80. That’s a saving of $960 per year or $24,000 over 25 years.
So clearly, it’s worth calculating the cost of a mortgage and comparing it with at least three other options on the market. But also, take into consideration any interest rate movements, because the better prepared you are for your home loan the more comfortably you’ll live.