Thursday June 9 2022

Interest Rate Real Talk - June, 2022

Well team, we knew it couldn’t last forever. With a second consecutive cash rate increase now under our belt (and the biggest single rise to the cash rate in 22 years) it appears that interest rates are definitely rising, with the widespread expectation that they still have a way to go. And while no one really knows what's going to happen (not even the RBA predicted this timing) most economists seem to be confident that interest rates will now be rising for a while to come, or at the very least have a ways to go yet.

Having come from a period of ‘all-time low’ interest rates and ‘once in a lifetime’ economic conditions, we are now sailing into a financial future shrouded in uncertainty. But remember, we are sailing together, and while we know that navigating these periods of uncertainty isn't always easy, we’re all in the same boat.

That's probably more than enough references to sailing for one introduction, so let’s have a chat about what this new period of increasing rates means on the mortgage side of things.

Rate Increases

Considering that the RBA’s position until very recently was no increase to the cash rate until 2024, it just goes to show how little anyone really knows about where things are going. And while there’s sure to be lots of ‘doom and gloom’ in the media about the rate rises (and look to be fair, they definitely aren’t fun) it is important to remember that they have been on the cards for a while.

If you’re interested, here are some pieces we’ve been reading:

Another interest rate rise expected in June: what will it mean for you? - Canstar

How the two iron laws of Australia’s property market put the squeeze on every generation - The Guardian

RBA’s most recent rate decision commentary - Statement by Governor Philip Lowe

Negative Equity

While again, no one can know for sure, there is talk that this forecasted period of rising rates may also trigger a decline in property values. In particular, the term ‘negative equity’ is being thrown around a fair bit, so let’s have a chat about what that means.

Negative equity is when the balance of your mortgage exceeds the value of your property. This most commonly occurs during property market downturns. The size of your deposit when purchasing a property is the main buffer to help protect you (and the bank) from falling into negative equity. It’s one of the reasons why banks have traditionally preferred a 20% deposit, which allows quite a bit of breathing room for changes in property market values. More recently though, they’ve allowed people to purchase with less than a 5% deposit in some instances - a significant reduction in the equity buffer.

Again, while no one can predict what will happen to property prices over the coming years (remember that covid-induced market crash that was supposed to happen back in 2020?) it's important to understand the implications of falling into negative equity, particularly as interest rates begin to rise. Property cycles are all part of the process, and there’s nothing wrong with house prices fluctuating, as is the case with other assets. For example, we expect the share market to rise and fall as part of its natural cycle. We’re just not that used to seeing property market downturns in Australia. If you plan on holding your property for the long-term then this sort of fluctuation is to be expected and can be weathered, especially if it’s your home - and can’t put a value on a roof over your head.

However, if you’re thinking of selling, up/downsizing or refinancing in the short to mid-term, then changes in your equity position might have more of an impact on you. If prices do trend significantly downwards and your LVR exceeds 80-85%, you might find it difficult to refinance or borrow more money without having to pay Lenders Mortgage Insurance (LMI), which can be in the tens of thousands of dollars (depending on your loan amount). If you find you have to sell your property, and you move into negative equity, you could be left with residual debt after the sale.

When the market is flaming hot, like it has been during covid, it feels like equity is an extra gift post purchase. But when the market returns to normalcy, the only way to earn equity is to diligently pay your repayments, even more so when equity starts to go backwards. The other alternative is to sell and wait for the bubble to burst, and the Australian property market has traditionally been too strong for that to be a workable option. Hang in there, keep up with your repayments, pay a little extra if you can (even $10 a week can shave a year off the average loan), and know that the bank won't make a fuss if you lose a little equity in the short-term. The long-term outlook on property is far more positive. Thankfully, we've never seen this happen to anyone in our community, but if it is something you’re worried about, please reach out and we can do some modelling for you.

As always, everyone’s circumstances are different, and the only right way forward is the way that is right for you personally. Our advice? Have a think about your plans, goals and needs for the next 5-10 years, and get some trusted advice in setting up your mortgage accordingly.

What do I do now?

It’s really hard to answer this question definitively because a) everyone’s circumstances are different and b) as we mentioned earlier, no one really knows what the future holds for rates or the market. But, we’ll try our best.

Do I fix my loan?

If you’re really worried about further rate rises and budgeting stress, then it could be a good idea to consider fixing. Though it’s important to view this more as a way of giving yourself certainty and peace of mind, and not as a way of ‘beating the banks’ which is notoriously hard (or dare we say impossible) to do. It’s also important to note that fixed rates are a lot higher than variable rates at the moment, so if repayment certainty is your main priority, you would take the hit now, work it into your budget and lock in consistency of repayments and a degree of certainty for the future.

There is a possibility that fixing now may save you money if rates continue to rise, though it is also possible you’ll end up paying more interest than someone on a variable rate. The main takeaway here is - you can’t put a price on peace of mind. Remember though: fixed rate loans have break fees, which can be substantial. So, if you have plans to sell/refinance/move off a fixed rate in the near future, things could get expensive, especially if rates don’t rise beyond the fixed rate you take. Could it be that the banks want you to lock in a high rate now amongst all the panic? Just because a fixed rate is high today, it doesn't mean rates will rise that high in the future.

Look, it’s a tough one. So as always, reach out to us if you need a sounding board.

Do I stay on a variable rate?

Staying on a variable rate is cheaper now, and could possibly remain cheaper than the fixed rates that are currently on offer. However, this carries a degree of risk and, as we’ve seen, rates can rise pretty quickly. A variable rate also allows greater flexibility in terms of early repayments, interest offsetting, refinancing, and selling.

We know we say it a lot, but it’s even more important now: one of the best ways to protect yourself from rising interest rates is to build up your savings in your offset account, or to get ahead on your repayments where you can. This can really help keep your interest charges down, and building a bigger buffer for the future will keep you in a better position. If you are thinking of staying on a variable rate, we recommend reviewing your loan now and ensuring you’re starting from the lowest rate possible, ahead of future rises. (more on this later).

Should I refinance?

If you’re considering refinancing, remember that with rate changes yet to come and unequal market changes (it's possible that not all lenders will increase their rates equally), there is a risk that you might move to a lender who is cheaper right now but whose rates might increase in the coming months/years. Refinancing isn’t free and can negatively impact your credit score if you do it too frequently, so it's really important to also consider the stability of the lender (do their rates fluctuate a lot?) and whether they are responsive to loan reviews, as well as looking for a lower interest rate. FYI, this is the kind of thing we can help with.

Having said that, there are lots of cash back offers floating around at the moment (i.e. banks offering cash incentives for people to refinance their loans) so if you are looking to move or fix, it could be a good time to explore the market and settle on a lender for the next few years while we weather the anticipated rate rises.

If all, or a portion of your loan is already fixed, chances are you’ll want to stay put. It’s likely that rates aren’t going to be as cheap as they have been again for a while, so just continue reviewing the variable portion of your loan to help keep costs as low as possible. That said, if you anticipate a possibly rocky road ahead in terms of negative equity, or a change in your financial circumstances, then it might actually be worthwhile terminating your fixed contract now and moving on to a more flexible variable product to allow for future mobility, or to take a longer-term fixed rate, albeit at a higher cost.

Refinance vs. loan review?

You’ll often hear the mortgage industry talk about the importance of loan refinancing, particularly during times of interest rate fluctuations (like right now). But, here’s a little truth bomb that often gets left out of the conversation: you don’t necessarily have to refinance your home loan to get a better interest rate. Boom. 💥

Now before everyone gets the wrong idea, we’re not saying that refinancing isn't a good thing (it absolutely can be) but what we are saying is that if you want to secure a lower interest rate, then refinancing doesn’t necessarily have to be your first port of call. Sometimes (and to be completely honest, more often than not) a simple loan review can be all you need to get yourself a more competitive rate, especially if you are otherwise happy with your bank. And by loan review, we mean either you, or your mortgage broker, calling your bank and negotiating with them to lower your interest rate. We think this is such an important tool for managing the ongoing costs of a mortgage, that we do it on behalf of all our clients annually as part of our service. Take a look at some of the results here.

Thinking it’s time for a refinance? We recommend asking yourself these questions first:

  1. If I do refinance, is the new loan product being offered genuinely better than the one I'm already on? Similarly, is the bank I'm moving to notorious for rate fluctuations, or are they relatively stable? (Better the devil you know, and all that)
  2. What will the financial benefit be to me in real terms, once all costs have been factored in?
  3. Could I potentially get the same result from asking for a discount, or moving to a cheaper product, at my current bank? (Does your current bank have any comparable products (often they will), and is a move to a whole new bank really necessary? Has your broker really done all that they can to get your current bank to come to the table?)

You don’t often hear about the benefits of reviewing and renegotiating loans (in place of refinancing) because here’s another little piece of information that gets conveniently left out of the conversation: a mortgage broker gets paid for refinancing a loan, but not for reviewing one. In fact, lowering your rate at your existing lender could likely lower your broker's commission - so, make of that information what you will. A good broker, that is genuinely acting in your best interests, won’t put you through the rigmarole of a refinance if the net benefit is negligible, and often (as proven by our annual loan reviews) getting a better deal on your home loan can be as simple as just asking for one! Want us to do this for you? We thought you’d never ask:

While we would love nothing more than to be able to give everyone a fool proof solution to tackling rising mortgage costs, unfortunately it doesn’t exist. Everyone’s situation is different, and so, everyone’s course of action will also be different. The good news? Speaking with a mortgage broker about your options is almost always free, so definitely take advantage of that. 

As always, we are here to offer our support and with many of our team members being property owners themselves, we also have skin in the game. If you’d like to have a chat about your options, or are interested in hearing what we’re doing with our loans, you can reach us here →

The finance information contained in this post is general advice only, and doesn't take into account your personal circumstances or goals. You should always reach out, or seek professional advice, before making any financial decisions.

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