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Sunday / April 14.
HomemifinanceInterest Rates Rising! Property Prices Falling! We’re All Doomed… or Are We?

Interest Rates Rising! Property Prices Falling! We’re All Doomed… or Are We?

With the world in turmoil, Paul McKinley looks at steps we can take to protect our finances and our assets.

There’s no doubt about it we’re living in volatile times. Although we feel that we’re on the other side of the pandemic, emerging COVID variants are threatening our return to some degree of ‘normality’ as we’ve come to know it.

On the international scene, we’re seeing war in Eastern Europe, and the threat of war in various other countries.

Many western economies are facing rampant inflation and are on the cusp of recession. Governing bodies are scrambling to reign things in by pulling all sorts of fiscal levers, the most influential one being the official cash rate set by their respective reserve banks. Here in Australia, we’re facing our own challenges. Pre-pandemic, we were sitting pretty with official Reserve Bank of Australia (RBA) rates at an all-time low of 0.1% from March 2020 to Feb 2022. On the home loan mortgage front, this translated into corresponding low fixed and variable home loan rates for those of us striving to achieve the great Australian dream of owning our own homes.

And then BAM! Things were tipped on their head!

In 2022, we saw the RBA take a firm twohanded grip on those fiscal levers and drive the official rate up with successive rate rises, from 0.1% to 2.85% in November 2022. And, of course, the banks were very quick to pass them on.

When contrasted against the 16–18% variable home loan rates some of our older readers will remember back in 1990, money is still relatively ‘cheap’, yet there is still cause for concern with:

  1. Some economists forecasting property prices in some states to fall by up to 20% over the coming 12 months,
  2. Many homeowners coming to the end of their (protected) fixed rate term, and facing much higher rates when they switch over to new offerings from their bank, and
  3. Mortgage interest rates predicted to continue changing during 2023, with uncertainty as to which way they are headed, and for how long.

Before considering actions to take during these uncertain times, let’s quickly revisit some of the fundamentals of owner-occupied mortgages for those new to this field.

FIXED VS VARIABLE HOME LOAN RATES

Fixed rate home loans may also be referred to as ‘certain’ or ‘predictive’. In general, if a financial institution expects the official cash rate to increase in the future, its fixed rate will be higher than its variable rate. The inverse is also true.

When a mortgage holder elects to fix the rate on their home, they are generally expecting rates to rise in the future; they ‘hedge’ or ‘insure’ against that to avoid higher interest rates, and correspondingly higher monthly repayments.

Banks may offer fixed terms between one and 10 years, although most fixed rate terms today are between one and five years.

Variable interest rates on mortgages do as the name implies – they fluctuate, typically when the official RBA cash rates move (of course, the banks are often quick to pass on the rises, and a little slower to pass on the falls).

The Pros and Cons of Fixed Rates

While a fixed rate period may be three years, the total length of the loan itself is most likely to be 25 or 30 years. Upon expiry of the fixed loan period, you can either fix the loan again for another term at the prevailing market rates, or switch to a variable interest rate for the remaining period of the loan.

Pros:

  • Repayments do not rise if official interest rates rise,
  • Borrowers sleep at night without the concern of rate rises, and
  • Budgeting becomes more accurate.

Cons:

  • When rates drop, repayments do not – you’re locked in at the higher rate from the inception of the loan,
  • Unlimited additional repayments cannot be made without paying a fee,
  • Penalties are incurred if you pay the loan out early, and
  • Most fixed rate products do not allow for an offset account.

The Pros and Cons of Variable Rates
Pros:

  • There are usually more loan features that provide increased flexibility,
  • It’s usually easier to switch loans if your broker finds you a better deal,
  • You can pay down your loan sooner with additional repayments, and
  • Some banks offer offset accounts on variable rate loans.

Cons:

  • Budgeting can be harder as repayments go up and down,
  • The increased loan features could cost more in fees, and
  • The terms and conditions can be confusing.

SPLIT LOANS

One way to hedge your bets on interest rates is by splitting your home loan rate into a fixed and variable portion, so you can take advantage of both fixed and variable rates.

The variable portion of your split loan will allow you to make extra repayments to reduce your loan balance. However, if you pay it out while part of your loan is fixed, the fixed portion may incur fixed rate break costs.

Allocating a portion of your total mortgage facility to a fixed rate might give you greater peace of mind when variable rates fluctuate, as you can still afford monthly payments. Additionally, keeping a proportion of your loan variable gives you the option to benefit from offset or redraw capabilities on that share of your loan, and take advantage of falling rates, should they come through.

When contrasted against the 16–18% variable home loan rates some of our older readers will remember back in 1990, money is still relatively ‘cheap’, yet there is still cause for concern

SO, WHAT SHOULD YOU DO?

Even if we were allowed, by law, to advise people to adopt a particular strategy when it comes to home loan interest rates (which we’re not), it would take a brave – or even reckless – broker to do so, given the uncertainties we face right now.

The rate you choose to go with may differ depending on the purpose of the loan.

Fixed rate loans often appeal to property investors who aren’t looking to pay off their loan faster and value the simplicity and predictability of fixed repayments. These borrowers may also opt for ‘interest-only’ facilities if holding the property for a finite time, because they want to keep their repayments lower while banking on capital increases in their property.

First home buyers, with less equity in their home, might prefer a split rate home loan so they can get the best of both options – they can make extra repayments on the variable portion (and therefore increase their equity), while hedging against possible future rate rises with a portion that’s locked into their fixed facility.

Conversely, homebuyers looking to refinance, renovate or sell their property might decide on a variable rate home loan so they can remain flexible with the timing of their sale or refinance without penalty.

The best you can do is understand the various options available to you or engage an experienced mortgage broker to explore and explain the options for you. With full information, make an educated decision, based on your own personal circumstances, and what your ultimate objectives(s) are.

FIVE QUICK TIPS

  1. If you decide a fixed rate loan is right for you, make sure you read the fine print. It’s important to understand the type of variable rate it reverts to at the end of the loan period (not that you must remain with the same lender). Some standard variable rates that the fixed loan reverts to can be markedly higher than the introductory rate, which is sometimes called a ‘honeymoon rate’.
  2. Challenge your current home loan package regularly (or ask your broker to do it for you), to ensure it is the most competitive solution for you. Banks are not always quick to pass on rate drops, but you’ll quickly get their attention if you indicate you’re thinking of moving.
  3. Don’t forget – some banks offer optometrists a 90–95% loan to value ratio, meaning you only need a 5–10% deposit on new purchases and refinances.
  4. Use the services of an experienced mortgage broker. This saves both time and the inconvenience of shopping around with different banks as brokers have access to numerous lenders (likely 50+) and products. If you just go to your own bank, you’ll only get its current offering, which may or may not be the best option for you. You don’t pay for a mortgage broker’s services as the bank pays them when they settle the finance. Furthermore, brokers will not likely apply to lenders, and get a ‘decline’ decision, if the application does not fit bank policy.
  5. And finally, projected shifts in the current residential property market differ significantly between the east coast and the west coast… so again, make your decisions based on your own personal circumstances, and don’t be a sheep.

Paul McKinley is the Managing Director and resident Chartered Accountant of Optometry Finance Australia, an independent finance broker that works with optometrists Australia-wide. With over 30 years relevant commercial experience in the finance, automotive and accounting industries, Mr McKinley specialises in commercial funding with a strong focus on personalised client service and retention. Visit optometryfinance.com.au.