By Tina Howes, Mortgage & Finance Advisor – SmartMove
I remember when I bought my first home and within a few months there was a rate rise. I freaked out and was forced to redo my budget. Fortunately, it meant I simply had less play money for nights out. I was 24, so the extra $25 a week in loan repayments was a lot to me.
Fast forward to the GFC when rates went up to over eight per cent and then rapidly started to decline as the economy came to a halt. I had, out of fear, locked in at eight per cent at the peak of the market, so I wasn’t able to benefit from the rate reductions.
After the GFC recovery, rates started to increase again. That was in late 2010, over a decade ago, so for many of you – you would have only seen rate reductions.
So, what does it all mean?
- The RBA increasing rates as a way of cooling the economy (inflation is deemed to be too high and unemployment very low). This is called monetary policy.
- When the RBA increases rates, this impacts on the cash rate, the rate that banks source money in the overnight market, so they pass this rate increase onto their customers. Unless they are on a fixed rate, because those customers will not see a rate increase impact them.
- Higher loan repayments mean less money for people to spend, so this reduces the amount of spending in the economy – therefore cooling things.
- Secondly, when there is the threat of further rises, people tend to be nervous, consumer sentiment drops, and people start to save rather than spend. This itself, can have a cooling effect on the economy.
- The banks source just under 50 per cent of their funds to lend to consumers from wholesale markets (local and foreign). So, the cost of funding to banks (that is, the rate they pay on this money in the market) can be increasing regardless of what the RBA does. When we hear of foreign banks increasing their cash rates, this impacts on the cost of funding for wholesale money. When this happens, we see the banks raise rates independently of the RBA.
- The other 50 per cent comes from deposits funds, when you leave your money with a bank, they can on lend that. Technically, an increase in the cash rate should result in the banks passing on the increase to deposit holders. So far only some banks have passed on this increase to their deposit holders. If you have cash, now is a good time to shop around and see who has passed on the rate increase to their deposit holders.
- Sometimes, the RBA only raises 0.10-0.15 per cent, which in the past has given the banks to ability to add another 0.10-0.15 per cent to their rates to recoup some of their costs. This has the same cooling effect by reducing the amount of spending in the economy.
If you are concerned about rate rises, what can you do?
Contact your bank and broker and obtain some fixed rates. The media doesn’t like to mention this, but fixed rates are already very high, having anticipated at least a two percentage-point rate increase now.
If you are prepared to lock in at rates of two to three percentage poitns over the variable rate, please be very certain you feel rates are going to increase at least to this level, and then some, before you pay the premium from day one.
You are essentially locking in a forecast fixed rate, without any certainty that it will eventuate. Rates may very well go up by two to three percentage points in the next three years, but they may also go up, then down again, if the economy slows down too much.
Be wary of any lender that encourages you to fix in without a solid reason as to why they think it’s a good idea. “Just protecting yourself from future rate rises,” is not a solid reason.
Ask your lender or broker what your repayment looks like with another 0.50 per cent, 1.00 per cent, 2.00 per cent – or whatever amount is keeping you up at night.
Redo your budget based on the increased repayment and make sure you can afford it and take steps to ensure you can afford it.
We know rates are on the rise. They were at emergency levels. Be prepared, put aside additional money now so that you have a buffer to use towards higher repayments.
Keep abreast of what a variety of commentators are saying about rate rises. Knowledge is power.
If you’ve obtained a loan in the past five years, the lender would have added a buffer of at least 2.50 per cent to the actual rate, so, technically you can afford the loan. If you obtained the loan prior 2014 (when rates were around 4.50 per cent chances are the rates were much higher then, compared with where they are forecast to go, so again you should be able to afford it. But that’s a very simplistic view and circumstances change as well as the general cost of living having increased.
If you haven’t got a loan yet, how do you protect myself?
Look at the repayments at current rates and add two or three percentage points. Make sure you can afford it and that there is enough discretionary spending in your budget to be able to still make it work.
It may mean eating out less, or fewer holidays, but this is exactly the intention behind the rate increases. It is designed to stop you spending as much and therefore cool the economy.
If you are unsure if you can afford it, try living as though you have the mortgage already. Try it for a period of three months (factoring in your rent as a mortgage repayment) and see if it’s doable.
And be mindful of borrowing at your maximum and obtaining a pre-approval. It’s very possible that by the time you have purchased, the servicing criteria from the banks will have changed and you will be left not being able to borrow the same amount.
Disclaimer: This article contains information that is general in nature. It does not consider the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. This article is not to be used in place of professional advice, whether in business, health or financial.
