How to prepare for an interest rate increase

Over the next couple of years, homeowners are likely to see rising home loan interest rates. The Reserve Bank of Australia will increase the official cash rate gradually as the economy recovers and stabilises after the COVID-19 pandemic, but lenders may increase interest rates prior to this occurring.

As interest rates rise, your home loan repayments may too. This will be more of an issue for borrowers with larger loans, but it’ll affect anybody who has borrowed money.

Here we’ll provide some tips to help you prepare for potential home loan interest rate increases.

• Related: How much interest you're actually paying over the life of your loan
• Related: Buying a property? How to be the ideal borrower and get approved for a home loan
• Related: Supercharge your monthly savings with our 8 handy tips

1. Review your budget

There’s a chance that your home loan is going to be costing you more soon, so it’s smart to see where you could save money in other areas of your life. Start by thoroughly analysing your current budget, spending habits and savings.

Consider whether there is room for improvement in how you spend your money. For example, as delicious as takeaway dinner from your local Thai restaurant may be, does it really need to be a weekly thing? Consider saving takeaway and restaurant meals for special occasions - at least until you get on top of your financial situation.

You may also be able to negotiate things like phone and internet plans, electricity charges and more. Many providers are willing to give loyal customers a better deal, and all you have to do is ask.

But before you start shifting around your budget, make sure you have a healthy amount sitting in an emergency fund. You never know what kinds of surprises life will throw at you that could have you flying across the country last minute, for example. An emergency fund means you can cover unexpected expenses without having to get into debt.

The Australian Government’s Moneysmart website has a useful budget planner to help you keep track of where your money is going.

2. Pay down your other debts

Having multiple debts at once can be overwhelming at the best of times, but it can become more stressful if interest rates rise. Interest rates may also rise on other credit products, not just home loans. So, it’s a good idea to see if you can pay down your other debts. These may include:

• Credit cards
• Personal loans
• Car loans
• Bills (e.g. gas, electricity, phone, internet)

You can also consider streamlining your debts under your home loan through debt consolidation. This refers to bundling your debt (e.g. car loan, personal loan, credit cards) together with your mortgage so that you simply make one monthly repayment. Doing this can reduce the risk of you accidentally missing repayments and damaging your credit score. Plus, you’ll benefit from the lower interest rates associated with home loans.

Doing this doesn’t mean you have to repay those debts over the remainder of your home loan term and risk spending more in interest. You can select a timeframe under which you repay your consolidated debt within your home loan. For example, if you have 10 years left on your mortgage term, you could set a 3 year repayment period for your consolidated debt.

3. Make extra repayments on your home loan

The smaller your loan balance, the less interest you’ll be charged. So if you can, work on putting some extra money towards your home loan in the form of additional repayments. Those with a variable interest rate on their home loan can typically make unlimited extra repayments, but fixed rate borrowers should be aware of any restrictions on making extra repayments.

Some lenders will penalise fixed rate borrowers for making extra repayments by charging break fees. All borrowers should be smart about making additional repayments on top of their usual ones - don’t make extra repayments if you can’t actually afford to do so.

4. Put your savings in a high interest savings account

Higher interest rates aren’t bad news for everyone! If you have a lot of cash saved, make sure it’s sitting in a high interest savings account. When interest rates go up, you’ll earn more interest on your savings.

Try to avoid withdrawing money from this account as the more money you have in it, the more interest you will accrue. Some banks also might not give you interest if you withdraw money from your savings regularly.

5. Consider buying sooner

If you’ve been planning on purchasing property but have been waiting for the right moment, now could be the time. If you buy sooner, you’ll increase your chances of finding a home loan with a competitive interest rate - particularly if you’re looking at fixed rate mortgages. You could also find that your borrowing power decreases as lenders have to factor in higher interest rates when calculating loan serviceability.

In saying this, don’t buy if you’re not ready to. Buying before you’ve saved up a sufficient deposit could result in you being charged Lenders Mortgage Insurance (LMI).

This also applies to buying cars with a car loan. Car loan interest rates are already higher than home loan interest rates, and they’ll likely rise too.

6. Review your home loan and consider refinancing

This could also be a good time to consider refinancing, or at the very least review your home loan. If some time has passed since you last refinanced (or initially obtained your loan), you may not have the most suitable loan for your circumstances or interest rates may have dropped.

For example, you may have a higher income, more savings, and could make use of an offset account. Offset accounts help reduce the amount of interest charged on your home loan, and could offset the impact of an interest rate increase.

If you’re not sure whether your home loan is still a good fit for you, consider speaking with a mortgage broker for free expert advice.

7. Consider fixing your interest rate

If you currently have a variable rate home loan, you may wish to consider switching to a fixed interest rate. Given that interest rates might gradually rise over an extended period of time, you could experience significant fluctuations in your repayments.

Moving to a fixed rate allows you to lock in a single interest rate for a period of time (usually 1 to 5 years). This can provide you with stability and reassurance in a potentially turbulent time. It will also mean that you’ll know exactly how much you’ll owe each month, and budgeting becomes a breeze.

Read more about the benefits and drawbacks of fixed rate home loans here. If fixing your entire home loan doesn’t appeal, you could also look into split rate home loans.

Rising interest rates can create stress and uncertainty. It’s smart to keep an eye on property and finance news, and speak to a mortgage broker or expert for home loan guidance.

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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.