A big question on many homeowners’ minds this year is ‘how high will interest rates rise?’
If you have a home loan, it's natural to wonder how high your repayments could climb and if you should consider fixing your rate to avoid future rate hikes.
While there’s no guaranteeing what will happen, there are a few predictions on how the cash rate might progress. We cover these predictions, how to prepare for rate rises, and how the cash rate rises will affect borrowing power and house affordability.
Several predictions on how high the cash rate will climb have been floating around as Aussies expect further cash rate hikes to occur this year.
In May, the cash rate increased for the first time in over 11 years to 0.35%, up 25 basis points from a record low 0.1%. It lifted again in June, increasing by 50 basis points to 0.85%.
Historically, we’ve seen the cash rate rise and fall by 0.25% increments, so it’s expected that home loan interest rates will rise by the same amount.
One source says the cash rate will likely go as high as 1% by the end of 2022, increasing a further 0.5% to 1.5% by mid-2023.
Another source expects the cash rate to reach 2.5% in the Reserve Bank of Australia’s (RBA) attempt to curb rising inflation. But, a time frame has not been laid out.
It says that Philip Lowe has estimated an official cash rate (OCR) at this level would represent a ‘neutral’ cash rate in Australia. A neutral cash rate is one that no longer stimulates the economy or boosts inflation but also does not put a halt on economic growth.
With inflation reaching 5.1% in March, it’s expected we’ll finish off the year with an inflation rate of 5.9%, almost double the expected wages growth of 3%. This means households will likely experience an estimated 2.9% decline in purchasing power.
This outlook is not all bad for prospective home buyers who may be intimidated by rising rates. The RBA has said that if the cash rate were to hit 2.5%, dwelling prices would likely fall by 15%.
If the cash rate continues to climb, it’s highly likely that home loan interest rates, as well as interest rates on other loan products, will rise as well.
Banks and lenders can set their rates independently from the cash rate. But, because the cash rate affects how much interest banks have to pay on overnight borrowing, they will typically:
Wondering how home loan repayments could be impacted by rate rises? Let’s look at an example of an owner-occupier P&I loan over a 30 year loan term.
Here’s how monthly repayments could increase as a result of 0.5% incremental increases.
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If you have a fixed rate home loan, you won’t be affected by any fluctuations in your lender’s interest rate until the end of your fixed term. When this period ends, you’ll likely revert to your lender’s standard variable rate.
If you have a variable rate home loan, your home loan repayments will be affected if your lender decides to pass rate increases on to you.
If you have a split rate home loan, only the variable portion of your loan will be affected by interest rate changes.
Aussies saw house prices shoot up when the cash rate dropped to 0.1% in November 2020.
According to the RBA, household consumption dropped 12% in the June quarter of 2020 following the onset of COVID-19.
The RBA sets the cash rate each month to support steady economic growth. Due to the lull in spending at the start of the pandemic, they dropped the cash rate to 10 basis points to stimulate the Australian economy and encourage household spending.
As a result, the cost of borrowing money decreased, which meant more people could afford to take out bigger home loans. Growing demand eventually outweighed housing supply, which meant dwelling prices could grow.
So, as interest rates start rising, we can expect the opposite to happen.
As the cost of borrowing money increases, fewer people will be able to afford a mortgage as their borrowing power dwindles.
We’ve already started to see dwelling prices in Sydney and Melbourne drop off as housing affordability reaches an all-time low.
In May, the CoreLogic home value index recorded its first decline in house prices since September 2020 to 0.1%, with Sydney dropping 1% and Melbourne 0.7%.
Borrowing power, also called ‘borrowing capacity’, is the amount of money you’ll likely be able to borrow from a lender for a home loan.
Your borrowing power is based on several factors, including:
Calculate your borrowing power based on your income.
Higher interest rates mean higher costs for borrowing money. If the cash rate stays on the same upward trend, people could expect their borrowing power to decrease further.
Stricter lending policies and tougher serviceability tests for home loans mean that lenders are required to ‘stress test’ home loans. This tests to see if borrowers would still be able to afford their home loan if interest rates rose by 3%.
So, the combination of higher interest rates, stricter serviceability tests and lower borrowing capacity means that some borrowers may find it more difficult to take on a mortgage.
Borrowers can expect the cash rate to increase further in the coming months, following the first cash rate hike in over 11 years in May.
Having steady repayments may be a priority for some borrowers. If this is true for you, you might want to look into fixing your interest rate.
Fixed interest rate home loans allow you to lock in a rate for a specified period of time (usually 1-5 years). This means that over the fixed period, your home loan repayments will remain the same, regardless of changes to the cash rate or your lender’s interest rates.
While fixed rates on offer are typically higher than variable rates, it can be difficult to predict how high interest rates will rise in the coming months and years.
If you’re thinking about fixing your rate, reviewing your loan options or just want home loan help, book a time to chat with an expert.
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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
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