RBA holds: How will borrowers with big home loans fare once rates rise?

The Reserve Bank says it still has no intention to raise the cash rate before 2024, but new research suggests many Australians are taking the view that lenders’ interest rates will increase much sooner. With that in mind, one expert says now could be an ideal time for borrowers to put a dent in their mortgage debt, while interest rates are low.
RBA April 2021
How will those who have taken out large mortgages on record-low rates manage once rates inevitably rise? Image source: Photographee.eu, Shutterstock.com.

The Reserve Bank of Australia (RBA) decided to leave the official cash rate on hold at the historic low of 0.10% today, helping to keep home loan lending rates low. The RBA’s Governor Philip Lowe reiterated today that the central bank had no intention of raising the cash rate until inflation and wages growth numbers improved – likely in 2024 “at the earliest”.

But new research from Canstar^ shows 40% of Australian adults surveyed, think home loan interest rates will rise sometime between now and the end of 2022.

The top three reasons for anticipating rising interest rates were predictions that Australia’s economy will recover by then (42% of respondents), inflation will rise (39%) and property price growth will need to be slowed (33%).

A further 24% of respondents think home loan rates will rise because the RBA has said the cash rate will go up.

Whenever rates rise, whether it’s soon or a few years off, concerns are rising among some regulatory and consumer groups as to how borrowers who have taken out large mortgages on record-low rates will manage once rates inevitably go up.

Canstar money expert Effie Zahos said the best thing borrowers could do right now to protect themselves financially is to increase their ‘cushion’ by focusing on knocking down mortgage debt.

“The thing is, after borrowing for a house, many of us are also taking out car loans, credit cards or buy now pay later, racking up our personal debt even more,” Ms Zahos said.

“We’ve got this period of potentially a few years up our sleeves where rates are low. If you’re not focusing on knocking down that mortgage debt, then you really only have a small buffer to protect yourself when the market does turn.

“We’ve seen property prices continue to grow, so there’s a fear of missing out. We’ve also got record-low mortgage interest rates, responsible lending changes are on the cards and banks are continuing to lower their serviceability buffers,” Ms Zahos said of the current environment for borrowers.

When a customer applies for a home loan, banks use the serviceability rate as a kind of “stress test”, to work out whether the person could afford the repayments on the amount being borrowed if there was an interest rate hike in future. National Australia Bank, for instance, has lowered its floor rate to 4.95%.

Lower serviceability floor rates can make it easier for some borrowers to qualify for a home loan, and even borrow a lot more in some cases, Ms Zahos said, at a time when people are already taking on a lot of debt.

Canstar research analysts crunched the numbers to determine how increases to the cash rate could affect borrowing power in future.

They worked out that a hypothetical owner-occupier on the current average full-time wage in Australia (about $89,000 according to the Australian Bureau of Statistics) would have a borrowing power of around $604,000 at the average floor rate of the major banks, assuming they qualified for the cheapest home loan rates on our database for a 20% deposit. Our analysts also calculated what this person’s borrowing power and repayments would be if they didn’t borrow at their full capacity but borrowed $100,000 less.

They found one cash rate increase of 0.25% could see people who borrowed $100,000 less save themselves $379 in monthly repayments, compared with what they would be paying if they borrowed the maximum amount, assuming their bank passed on the rate rise in full.

If what happened after the Global Financial Crisis – where the cash rate was increased six times between October 2009 and May 2010 – were to occur again in three years’ time, monthly repayments could be $440 more for this average borrower if they took out a loan at their maximum borrowing power now, compared to if they borrowed $100,000 less.

Regardless of how the cash rate may move in the future, Ms Zahos said borrowers seeking peace of mind could refinance to a better rate and consider locking in a record-low rate for the long term.

“It’s a big myth that fixed rates aren’t always flexible. Ask your lender if you can make extra repayments, and some fixed rate loans still have an offset account. Of course, if you’re going to sell during that fixed period it does not make sense to lock in because of the break costs that often apply.”

For borrowers who are torn between fixing their home loan or going with a variable rate, there is another option that offers a mix of the two that may be worth exploring: a split home loan.

Interest rate moves in March

According to the latest numbers, Canstar has 179 home loans interest rates below 2% on its database. Of these, 157 are fixed and the other 22 are variable.

The lowest variable rate on our database for a $400,000 loan for owner-occupiers paying principal and interest is 1.77% (1.86% comparison rate) with a 60% loan-to-value ratio (LVR), while for an 80% LVR the lowest variable rate is 1.99% (2.05% comparison rate) and the average is 3.28%.

The lowest three-year fixed rate on the database for owner-occupiers paying principal and interest at 80% LVR is 1.75% (2.22% comparison rate) and the average is 2.28%.

Here’s a summary of how home loan interest rates on Canstar’s database moved in the past month:

  • 12 lenders cut 30 variable rates by an average of 0.16 percentage points.
  • 2 lenders increased 2 variable rates by an average of 0.04 percentage points.
  • 25 lenders cut 186 fixed rates by an average of 0.23 percentage points.
  • 13 lenders increased 67 fixed rates by an average of 0.21 percentage points.

^Survey of 980 Australians aged 18+. Commissioned by Canstar and conducted online via Qualtrics in March/April 2021.

Thanks for visiting Canstar, Australia’s biggest financial comparison site*

This article was reviewed by our Sub Editor Tom Letts and Deputy Editor Sean Callery before it was updated, as part of our fact-checking process.

Ellie McLachlan is responsible for leading and breaking financial news on home loans, savings and much more. Ellie studied a Bachelor of Journalism and Arts at UQ and has worked at major metropolitan and regional news organisations.

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