Why you should listen to your gut first, then your lender

Why you should listen to your gut first - then your lender

Using a home loan calculator will help you find out how much you’ll pay on your mortgage over the years. But have you considered what would happen if interest rates soared?

The nation’s official cash rate, which is set by the Reserve Bank of Australia (RBA), is currently 2.5 percent.

A low cash rate is favourable for those looking to take out home loans, given that it allows lenders to offer more competitive rates but while banks are willing to lend you the money now, while the rates are low, have you considered how your circumstances would change if rates rose? The current low rate has been stable since August 2013, making the one question on everyone’s lips: “When will it rise and how will that affect me?”

How long will low interest rates be around?

Glenn Stevens, Governor for the RBA offered a positive answer in the most recent monetary policy decision:

“In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.”

While this is good news for those seeking home loans in the near future, the official cash rate will probably lift at some point. Existing homeowners paying off their mortgage as well as those entering the real estate game in months and years to come will need to grapple with the idea of higher interest rates — meaning greater repayments.

Making a financial commitment that lasts for decades

For most Australians, buying a property is the single largest financial commitment they’ll make in their lifetime. 

It’s essential to utilise tools like home loan calculators and budget spreadsheets in order to establish the true cost of home ownership. Initial one-off costs, regular loan repayments and ongoing maintenance and repair costs can quickly mount. That’s not to say owning a home isn’t a smart move — it just requires a high level of pre-planning before diving in head first. 

That said, some individuals are stepping onto the property ladder without adequate financial backing, with some lenders being accused of offering risky home loans, according to consumer advocate site CHOICE. Low-deposit or no-deposit loans are being offered, as well as mortgages that require family members to step up as guarantors.

Lenders Mortgage Insurance (LMI) is usually required if you borrow over 80 percent of your home’s value so if your deposit is less than 20 percent of your desired property’s value, you’ll have to account for this extra cost.

However, LMI won’t rescue homeowners who can’t honour their mortgage repayments — it’s simply protection for the lender.

Could you afford higher repayments?

Of course, not all borrowers go beyond their means when taking out a home loan. However, it’s imperative to look into the future.

If the official cash rate was to soar in the future, those on variable-rate loans need to be sure they can absorb increased repayment costs without detrimentally affecting their savings accounts or retirement savings.

According to the Bankers Association, the average standard variable home loan interest rate (SVR) between January and March 1990 was a whopping 17 percent. This is the highest SVR between 1990 and 2012.

If someone was to take out a home loan at this rate today on a $300,000 property over a 25 year term, they would pay $4,313 per month and pay $1.29 million in total, including principal and interest.

That is over double what most home borrowers are currently paying in this low rate market. At a 7 percent interest rate, a borrower would pay $2,120 per month, paying $636,100 in total, including principal and interest.

So, ask yourself: If interest rates were to soar dramatically, could you foot the bill?

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Learn more about home loans

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Variable rate

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Split rates home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

What is a standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

Remaining loan term

The length of time it will take to pay off your current home loan, based on the currently-entered mortgage balance, monthly repayment and interest rate.

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is a fixed home loan?

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

What is 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.