Rising rates: How to reduce mortgage repayments by up to $600 a month

Worried about how you’ll manage your repayments with rates rising? Find out how you may be able to reduce your repayments by up to $600 a month to help ease the stress.

The Reserve Bank increased the cash rate by 50 basis points at its August meeting bringing it to 1.85%. This is the fourth time this year we’ve seen an official rate hike. If you’re already feeling the pinch of rising interest rates it’s time to take action as rates are likely to continue their upward trajectory. One major bank is forecasting that the Reserve Bank could raise the cash rate to 3.35% by the end of the year and all the majors are factoring in further cash rate increases.

For anyone with a variable rate mortgage that could mean a rapid rise in repayments by Christmas. If the cash rate hits 3.35% someone with a $600,000 mortgage could see their monthly repayments jump up about $1,000 in total since the first rate hike in May.

“If you’re alarmed by the prospect of further rate rises or are already feeling financially stretched thanks to rising grocery and petrol prices there are ways to manage your repayments,” said Canstar Editor-at-Large Effie Zahos.

5 ways to reduce mortgage repayments

Here are five strategies that can help you claw back some of your mortgage repayment increases.

1. Stretch your loan term

You can potentially reduce your monthly repayments by extending the term of the loan. “Some lenders even offer a 40-year loan term although these are usually reserved for first home-buyers because you’ll be paying it off for most of your working life,” explained Ms Zahos.

Let’s say you’re paying off a $600,000 home loan over 20 years and are paying 3.85% interest. By increasing the term to 25 years your monthly repayments would be reduced by $471. It’s important to note, though, that this will end up costing you an extra $73,990 in interest (see table).

“Increasing your loan term will give you some relief but it will cost you more in interest. It’s a great band-aid solution but when you’re in a better situation you should try to pay more than the minimum repayments to potentially reduce the extra interest cost,” suggested Ms Zahos.

Impact of increasing the term of your loan

← Mobile/tablet users, scroll sideways to view full table →

Source: www.canstar.com.au – 22/07/2022. Average variable interest rate based on owner occupier loans available for $500,000 and 80% LVR on Canstar’s database; excluding introductory and first home buyer only home loans. Repayment calculations assume principal & interest repayments made on a $600,000 loan amount over the applicable loan term.

Pros

• Paying the loan off over a longer period will reduce the amount of your regular mortgage repayments.

Cons

• As you are paying off the principal at a slower rate you’ll pay more in total interest over the life of the loan.
• If you’re already on a 30-year term you probably won’t have any room to manoeuvre.

2. Switch to interest-only repayments

With owner-occupier home loans, the mortgage repayment generally pays off the interest and some of the principal. Another way to reduce the amount you need to fork out each month is to switch to interest-only repayments.

“Interest-only loans are generally used by investors as it frees up their cashflow and may also offer potential tax benefits. But they can also offer some breathing space for borrowers who need to reduce their repayments,” explained Ms Zahos.

As you can see from the table below, switching to interest only on a $600,000 loan for five years could potentially reduce your monthly repayments by $608. But, like extending your loan term, it means you’ll pay more in total interest.

“You should really only use this as a temporary measure as it will end up costing you more in interest in the long run,” said Ms Zahos. “As soon as you can afford to go back to principal and interest you should.”

Principal and Interest vs Interest Only for five years

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Source: www.canstar.com.au – 22/07/2022. Average interest rates based on owner-occupier loans available for $500,000 and 80% LVR on Canstar’s database; excluding introductory and first home buyer only home loans. Repayment and interest calculations assume repayments are made at the end of the month, and that the interest-only loan reverts to the average principal & interest variable rate at the end of the interest-only period for the remaining loan term.

Pros

•  If you’re no longer paying off the principal the repayment will be smaller.

Cons

• As the repayment is no longer paying off the principal the total interest paid over the life of the loan will increase.
• Rates on interest-only loans tend to be higher than principal and interest loans.
• You’re not building any equity in your home while you’re only paying off the interest.
• Usually, lenders will only allow borrowers to pay interest only for a limited time – generally between one and five years. Repayments will then revert to principal and interest and your budget needs to be prepared to bear the strain of higher repayments.

3. Request a pause

“If you are struggling to make repayments you can talk to your lender about entering a financial hardship arrangement. Your lender may agree to pause your repayments temporarily,” suggested Ms Zahos.

During COVID-19 lockdowns plenty of people requested – and received – a repayment pause. Some had lost jobs or had to close the doors of their businesses and their income was under pressure.

“Keep in mind though that interest will still be accruing while you pause your repayments,” warned Ms Zahos. “It’s also worth noting that if you enter a financial hardship arrangement it will be included on your credit report.”

Pros

• When you experience temporary troubles that impact your income such as a job loss, accident, or illness a repayment pause allows time for the problems to resolve and new solutions to be found.

Cons

• Even though you stop making mortgage repayments for perhaps six months the repayments and the interest are still accruing. So you might need to make larger repayments or repay over a longer period when the pause ends.
• If the problems continue for longer than the agreed repayment pause you might need to consider tougher measures such as selling your home or other major assets.

4. Refinance or negotiate a better rate

Lenders are always jostling for new customers. If you spot a better interest rate in the market run the numbers to see if it’s worth refinancing.

“It’s a good idea to calculate your break-even point when thinking about refinancing. To do this add up all the costs of moving (include any fees to discharge your mortgage and any fees your new lender may charge) and divide this by your monthly savings,” said Ms Zahos. “If, for example, it costs you $1,000 to move but you would save $50 a month in repayments, your break-even cost is 20 months, meaning it will take you just under two years to recoup the cost of moving.”

Let’s say you have a $600,000 mortgage over a 30-year term and are paying 3.85% interest. Your repayments would be $2,813 a month. By switching to a loan charging 2.49% (currently the lowest variable rate on Canstar’s database) your repayments would be $2,368 a month – a saving of $445.

Alternatively, your existing lender might be offering a sweeter deal to new customers. If that’s the case, try your hand at some negotiation tactics.

Impact of refinancing to lower variable rate

← Mobile/tablet users, scroll sideways to view full table →

Source: www.canstar.com.au – 22/07/2022. Average and lowest interest rates based on owner-occupier loans available for $500,000 and 80% LVR (for average variable only) on Canstar’s database; excluding introductory and first home buyer only home loans. Repayment calculations assume principal & interest repayments made on a $600,000 loan amount over a 30-year loan term.

Pros

• Refinancing is a way to secure a lower repayment because you only need to take out a loan for the outstanding balance.

Cons

• There may be fees associated with refinancing. For example, the new lender may charge an establishment and/or valuation fee.
• If you have less than 20% equity in your home, you may be up for Lenders Mortgage Insurance (LMI) – even if you already paid LMI when you first took out a loan.
• If you restart the term of your loan when you refinance you will end up paying more in total interest.

→ Related: Insider tips: How to haggle on your home loan in a world of rising interest rates

5. Rent out a room

There are so many avenues for using your home to earn some extra dollars. You could rent your spare room to a long-term tenant or boarder or try the short-term accommodation route. If you have underutilised space in your home, shed, studio, backyard, or garage you could offer it to someone needing storage. Or it may appeal to someone looking for a separate space to pursue a creative activity.

“If you are using your home to bring in some extra cash then make sure you factor in any tax implications,” said Ms Zahos. “You will need to declare the income on your tax return and you may have to pay capital gains tax when you sell.”

Pros

• You could lock in some regular rent or get some ad-hoc help with bigger bills.

Cons

• There can be additional costs associated with earning the extra income such as electricity, furniture, food and insurance.
• You need to consider the tax implications of using your principal place of residence to earn an income. It may lead to a capital gains tax liability.

Cover image source: Prostock-studio/Shutterstock.com