The latest meeting of the Reserve Bank of Australia (RBA) increased the cash rate to 3.6%, which is its 10th consecutive rate rise. The series of hikes has greatly increased the interest rates on home loans, raising monthly repayments and making it difficult to manage finances.
Are you aware of all the potential risks that cash rate hikes can pose to your home loan? This article will explore these risks and suggest ways to prepare for them.
What Are The Possible Risks?
When the RBA increases the cash rate, it means that banks will have to pay more to borrow money, which can directly affect homeowners. Here are some of the ways cash rate hikes can affect your home loan.
Reduction in property value
A cash rate hike can lead to a reduction in property values. Higher interest rates reduce borrowing capacity and make it more expensive for people to borrow money. This can lead to a decrease in demand for property and a fall in prices, which can be particularly concerning if you are looking to sell your property or refinance your home loan.
A reduction in property values can have several risks for homeowners. Firstly, it can reduce the equity in the property, making it hard to access it to fund renovations or other expenses. Secondly, if the value falls enough, it can lead to negative equity, where the outstanding home loan balance exceeds the value of the property. For example, the recent CoreLogic data shows that house prices in eight out of 10 Sydney suburbs have dropped at least a 10% from their recent peak, possibly pushing some homeowners into negative equity. This can make it hard for them to sell the property or refinance the home loan.
Difficulty in refinancing
A cash rate hike can make it harder to refinance a home loan, particularly in a falling market. Lenders may be more cautious about lending money, which can limit options for borrowers seeking to refinance.
Interest rate rises can increase living costs, making it harder to meet the bank’s serviceability requirements. This means more prospective refinancing applications will be rejected.
The difficulty in refinancing can limit options for borrowers, making it harder to find a competitive interest rate. This can leave borrowers stuck with their current home loan, even if it is not the most suitable option.
Being Locked Into A Fixed Rate
Homeowners who have opted for a fixed-rate home loan may find themselves locked into a higher interest rate if the cash rate rises. This can make it difficult to switch to a more competitive rate and can result in higher repayments.
For example, imagine that you took out a fixed-rate home loan for $500,000 at an interest rate of 5% for a 3-year term. After two years, the RBA decreases the cash rate, causing variable rates to fall, making them more attractive to borrowers. However, you are stuck paying the higher rate for another year because you are locked into a fixed rate. If you want to take advantage of the lower variable rates before your fixed term expires, you may face break costs and fees.
How To Prepare For Cash Rate Hikes
Being prepared for cash rate hikes is important. By planning ahead, you can avoid some of the pitfalls. Here’s how:
Manage Your Living Expenses
Review your budget regularly and make sure you’re not overspending. Cutting back on unnecessary expenses can help you build a financial cushion that can be used to cover any increases in mortgage repayments. By managing your expenses carefully, you can avoid getting caught out by unexpected costs.
Have Some savings As A Backup
Another way to prepare is to put money into savings. This means creating a budget that considers any potential increases in your mortgage repayments or other bills and ensuring that you have enough money set aside to cover these expenses. Accumulating enough savings to cover your living expenses for a minimum of three to six months can help you handle unexpected expenses or keep up with your mortgage repayments if your income is reduced.
This can be a smart move if you’re concerned about interest rates rising in the near future. By refinancing, you can potentially secure a lower rate, consolidate personal debts, reset your loan term to 30 years or switch to a fixed-rate loan. All of these changes can give you more certainty about your mortgage repayments.
Improve Cashflow And Prepare For Higher Repayments
Improving your cashflow might mean cutting down on discretionary expenses, negotiating better deals with your lenders or even taking on a side hustle to bring in some extra income.
Make Extra Repayments
This means paying more than the minimum repayment amount each month to create a surplus that can be used to cover any future increases in interest rates. By paying off more of your loan sooner, you can reduce the impact of any rate rises and potentially save thousands in interest over the life of your loan. Not all loans allow extra repayments. Be sure to check the terms of your loan before employing this strategy.
The more equity you have in your home, the more financial flexibility you have and the more likely you are to qualify for lower interest rates and better loan terms. You can do this in several ways, including making extra repayments on your mortgage, increasing the value of your property through renovations or extensions, or simply holding onto your property until the value appreciates.
Review Your Home Loan Regularly
Make sure your home loan continues to meet your needs and is providing you with the best possible value. This might involve comparing different loan options, negotiating with your lender, or refinancing to a new provider. This helps you stay on top of any changes to interest rates or loan terms and identify any potential risks to your mortgage repayments.
Speak To A Mortgage Broker
Finally, speaking to a mortgage broker is a great way to get expert advice on how to prepare for a cash rate hike. A broker can help you understand your options and identify strategies that can help you save money and reduce the impact of any future rate increases.
Don’t Let Rate Rises Catch You Off Guard!
Home Loan Experts’ specialist mortgage brokers can provide you with personalised service that is tailored to your unique circumstances. Whether you’re looking to refinance, build equity, or just get the best possible deal on your mortgage, we’re here to help. So why wait?
Call us on 1300 889 743 or fill in our free online assessment form today and take control of your financial future!