Many recent home owners may have never had to face an interest rate rise on their home loan. But with changes predicted this year from the RBA, now is a good time to review your budget so you can feel prepared when the time comes.
How does an interest rate rise work?
The Reserve Bank of Australia (RBA) sets what’s known as Australia’s ‘cash rate’ – which is an interest rate charged on loans for banks and other lenders.
The cash rate impacts the rates that banks apply on their customers’ home loans, savings accounts and term deposits – and it hasn’t been raised since 2010. In fact, the RBA reduced the cash rate in 2019 (pre-Covid) to the lowest historical level Australians had ever seen.
Keeping the cash rate low or even reducing it is done in a bid to put more money in people’s pockets and stimulate a weaker economy. In Australia, those historically low rates have led to a period of cheap mortgages.
These temporary low interest rates helped many people save money during the pandemic as repayments decreased.
Why do interest rates go up?
In a strong economy, the RBA may decide to raise the cash rate in order to slow inflation, known as ‘restrictive monetary policy’. As the economy grows, so too do interest rates as well as the prices on goods and services.
Interest rates can change for variable deposit and lending products that fluctuate with the market, like your savings and variable home loan. If you’re on a fixed rate, your rate won’t change until your fixed period comes to an end and you revert to the standard variable rate.
How can you prepare for an interest rate rise?
- Many people choose to pay more than the minimum payments or may have built up some advance on their mortgages if they didn't adjust their repayments as interest rates decreased over recent years. Start by checking your current repayment amount and whether you are in advance to help smooth the transition to a new rate.
- Use a comparison calculator to forecast how much extra you may need to pay a month to cover a rate rise, to see where you stand. Start looking at your expenses and where you can cut back to cover the difference, especially if you’re making minimum repayments at the moment.
- If you have other debts, look at ways to consolidate them into loans with lower interest rates, or pay them off quicker so you can redirect that money towards your mortgage.
- You could also consider switching to a fixed rate home loan from a variable rate home loan if you’d like more certainty with your repayments for a period of time, but you should always do your homework to weigh up the pros and cons between the two options to decide what’s best for your personal situation.
- Same goes if you’re planning to shop around for a better deal on your rate and refinance. There can be additional costs such as break fees to consider first, so it’s a good idea to start by talking to your lender.
If you are feeling financial pressure, speak to someone at your bank or financial institution about hardship options available.