By Amy Bradney-George
November 10, 2009
Interest rate rises hit home for people with variable rate mortgages, despite being cheaper than most fixed rate loans. When looking at home loans it is easy to be drawn in by promises of low interest rates without considering all the conditions of the loan.
But, just like comparing different interest rates and features, looking at the long-term sustainability of a loan is a vital part of the home-buying process. Being able to financially manage an interest rate rise will help you stay on top of monthly repayments and take advantage of the lower rates variable loans offer.
It is difficult to calculate the interest on a variable mortgage because the rate will change over the life of the loan, but it is possible to determine how much change is manageable.
For example, if you took out a $300,000 variable loan for a term of 25 years, with an interest rate of 5.7 percent p.a., the minimum monthly repayment would be about $1,878.
If there was a rate rise of 2 percent monthly repayments would then be about $2,256, or $4,536 extra per year, which could be a struggle if the rise is unexpected.
Calculating the absolute maximum amount you could afford to pay each month will indicate how much you can afford if interest rates do rise. Currently, a competitive fixed rate would be around 2 percent more interest each month, so being prepared for a rate rise with a variable loan is likely to be a better alternative.
Paying more than the minimum
This option is often used to reduce the life of a loan, but it can also act as a safeguard against rate rises.
Increasing your monthly repayments by 10 percent would cover a rate increase of about 1 percent. Using the loan scenario above, if rates stayed the same at 5.7 percent p.a., the 10 percent extra would reduce the loan duration by four years and five months and save over $52,000 over the 25-year loan term.
If rates were to drop and you continued to make the same repayments, you would be further protected from any future increases and pay off the loan even sooner!
Comparing rates, features and overall loan affordability will help make a mortgage manageable while also taking advantage of a lower interest rate. Planning ahead now means less financial stress and a chance to reduce the years of mortgage debt.