What happens when interest rates rise?

Queenslanders are seeing home mortgage interest rates rise for the first time in 12 years.

Some of you may remember when interest rates were much higher, about 10%, which we thought was cheap considering previous generations paid 17%.

Considering how high interest rates have been in the past, it would still seem a good time to take out a home loan.

But what happens if interest rates continue to rise?

An RACQ survey* revealed one in 10 Queenslanders had experienced difficulties in meeting their loan repayments in the past 12 months, even in a low-rate environment.

Surprisingly, the main method of saving money was opting to change home loan providers.

There are a few things you can do to save money before switching home loan providers.

Ask your current lender if you’re on the best rate available and consider splitting your loan to lock in a portion at a cheaper fixed rate.

The danger with continuously chasing the lowest rate by switching providers is that the cost of establishing a new loan, including Lenders Mortgage Insurance and establishment and exit fees, can sometimes outweigh the benefits. More importantly, once interest rates rise, they will rise across the market so it will be difficult to continue to save money by switching loan providers.

In preparation for the rate rise, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate buffer it expects banks to use when assessing the serviceability of home loan applications.

This means prospective home buyers need to show banks they can afford loan repayments at an interest rate that is at least three percentage points above the loan product rate.

APRA’s actions should help to ensure new borrowers, or those who switch home loan providers, are able to afford the debt they are taking on, both now and into the future.

What can you do now to safeguard against home loan rate rises?

• Work out what the repayments on your loan would be if the interest rate increased by up to 2%. Setting yourself up now by making fortnightly repayments and paying more than the minimum will mean you have a bigger buffer as rates rise. Adjusting spending now means you won’t be caught out by higher rates. RACQ’s home loan repayment calculator can help you to work out know much your repayment would be if interest rates rise.
• Consider fixing your rate or splitting your home loan into part variable and part fixed rates to safeguard against any potential rate rises.
• Work out a budget and pay any surplus funds into an offset account or directly onto your loan.
• If you don’t already have an offset account, ask your lender if it’s an option for your home loan. This can be an easy way to reduce the overall interest paid on your loan and still ensure cash is available should you need to access it quickly. Treat this money as something you can’t access so you don’t spend it unnecessarily.

It is important to remember that planning for the unexpected and paying down a loan will provide you not only more peace of mind when your circumstances change, but will also work towards your overall financial wellbeing.

*Source: RACQ Quarterly Omnibus

The information in this article has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained in the document is general advice and does not take into account any person's particular investment objectives, financial situation or needs. Before acting on anything based on this advice you should consider its appropriateness to you, having regard to your objectives, financial situations and needs.