Build a home loan buffer to protect yourself from rising rates
Over the last few months, we've seen everyone from the big banks through to the smaller credit unions lift their home loan rates. Now with a large number of industry expects tipping the RBA will raise rates by 25 basis points at least twice this year, the low interest rate market we've enjoyed in recent years could be officially coming to an end.
But there is a silver lining for borrowers. While you can’t stop your lender from raising rates, you can give yourself a home loan buffer to protect your budget from future rate hikes.
Are you at risk?
Research has shown that 1 in 5 Aussie homeowners are at risk of plunging into severe financial stress, if the RBA lifts rates this year and home loan providers follow suit. Are you one of them?
Scenario: Say you were making monthly mortgage repayments at the average variable rate for a $500k loan. Our rate change calculator shows, even the slightest rate hike can drive up the cost of repayments...
| Interest rate | Monthly repayments | Interest paid over 25 years | |
|---|---|---|---|
| Average variable rate for a $500k loan | 4.35% | $2,737 | $321,029 |
| 25 basis point increase 50 basis point increase 75 basis point increase | 4.60% 4.85% 5.10% | $2,808 $2,879 $2,952 | $342,286 $363,826 $385,647 |
*For owner occupiers making principal and interest repayments
As the table shows, it doesn’t take much of a rate increase to make mortgage repayments significantly more expensive. If your lender hiked interest rates up by 25 basis points in this hypothetical situation, monthly repayments would increase by $71.
Stretch that over 25 years, and you’d be handing over $21,257 more to your home loan provider. Or, change the rate hike situation to 75bp and your retirement would be very different indeed. You’d be $64,618 worse off.
Even though that might sound rough, there are ways homeowners can approach a turbulent interest rate climate to reduce the impact.
Protect yourself from rising rates by...
1. Making extra repayments on your loan. Spare room in your budget for additional mortgage repayments now, while your interest rate is still at an affordable level. Being ahead on repayments will give you more leverage if your financial circumstances change and you need to apply for a repayment holiday.
2. Refinancing. We have a range of home loans in our database sitting below the 3.5% mark, so if you’re forking out too much with a lousy rate it’s time to refinance.
Scenario: Let’s say you were paying off $500k on the average variable rate each month. Switching to the best mortgage currently on our database with a variable interest rate of 3.35% would give you $274 more to play with every month, or $3,288 over a year.
3. Taking out mortgage protection insurance. Make that home loan buffer extra tough by taking out a mortgage protection insurance policy (not to be confused with lenders mortgage insurance). It’s simply an insurance to cover home loan repayments if you’re made redundant or become ill. You’ll pay a premium in return for the peace of mind that your mortgage expenses will be covered (to a certain amount and over an agreed period of time set between you and your insurance provider).