There’s been quite a lot of talk lately about interest rates going up. Interest rates increasing is one of the biggest concerns for property owners and those looking to get into the property market. We get asked a lot… “when do you think interest rates will go up?” – if only we had a crystal ball!
The truth is, there a many factors that contribute to interest rate increases…
Wholesale funding prices (the price the bank pays to secure the funding)
Economic indicators like inflation and employment
Consumer sentiment and the property market
Lender restrictions – like when banks were told to reduce the number of interest-only loans (rates go up to discourage borrowers)
Banks just decide to increase their interest rates to cover costs and improve profit
So, how do you protect your home loan from interest rate increases?
1. Fixed home loan interest rate
The simple answer to avoid interest rate increases is to fix your home loan interest rate. Under a fixed interest rate, the rate you agree to at the commencement of your home loan is the rate you’ll have for the agreed term, usually for 1,2,3 or 4 years.
Some lenders offer a 5 year fixed interest rate, but these are really only suitable for borrowers who have a solid strategy in place and aren’t looking to sell or refinance that property within 5 years, as the break costs to get out of the fixed term agreement could be high.
Things to consider
Easier to budget. You know exactly how much your repayments will be during your fixed rate term, which can make budgeting easier.
Less Flexibility. Fixed rate loans usually do not have the same flexibility that a variable rate loan provides. For example, you may not be able to make extra repayments and redraw them. Some lenders do allow extra repayments to be made, but will restrict the amount that can be paid during the fixed term or on an annual basis.
No offset facilities. Most lenders will not allow you to have an offset account with a fixed rate loan so there is no opportunity to save on interest. Where offset facilities are available, they will usually only be available on a partial basis, with a 100% offset account being available through some lenders only.
Break costs. You can expect to pay penalties if you want to exit before the end of the fixed term. Your reason for wanting to end the loan is not considered, and break costs also apply if you want to end the loan as part of selling the property.
2. Split your loan between fixed and variable
A popular option is to hedge your bets on interest rate increases and split your home loan into both a fixed rate portion and a variable portion. This is a good option for borrowers who want the security of a fixed interest rate but also the flexibility to have some of the home loan on a variable rate which provides access to an offset account.
Splitting your home loan is great for people who have inconsistent income and may receive bonuses, commission or dividend payments as part of their income. They are able to make larger repayments on the variable component which has an offset account for when their income fluctuates. The money you hold in your offset account reduces your repayments as the funds in your offset account are applied against your home loan balance before interest is calculated.
Things to consider
There are many kinds of offset accounts, and the features will differ depending on the loan type and lender. For example, not all offset accounts are 100%, some may only be partial. Fixed rate home loans may only allow 100% offset for a set period, or other conditions may apply.
You may incur monthly fees for having an offset account. It pays to look at the total charges associated with your home loan package to determine if having this product leaves you better off financially.
Some lenders may require a minimum balance in the offset account.
Remember, offset accounts and redraw facilities are very different. A redraw facility is a loan feature that is usually available with variable rate home loans and some fixed rate loans. A redraw facility lets you access any extra repayments you’ve made on your home loan. Always speak with your mortgage broker before you decide on the product for you home loan, so you can make sure the facility is suitable for your situation.
3. Lower LVR = lower interest rate
Over the last few years, the LVR (loan to value ratio) has become increasingly important when it comes to what discount the lender will offer on your interest rate. Lenders will offer a bigger discount on their standard variable interest rate if you’re borrowing less. That means, if you have a larger deposit to contribute, you’ll receive a lower interest rate, particularly if you are borrowing less than 80%.
Subsequently, if you are borrowing above 80%, you’ll have less swagger when it comes to asking the bank for a discount. And when you’re borrowing a lot of money, every little discount helps reduce your mortgage repayments, so it’s worth taking the time to save a little more money for your deposit to reduce your interest rate.
4. Revalue the property to reduce your LVR
So, we know a lower LVR = lower interest rate, but what if your property value increases during the time you own it? As proactive mortgage brokers, Mint Equity, conducts regular six monthly reviews of our clients’ home loan interest rates…and property values. We take the initiative to assess our clients’ property values every six months to see if there is an increase in value, which will in turn lower the LVR.
If there is an increase in the property’s value, we contact the bank and request a discount on our client’s interest rate. If the LVR has reduced, and the risk profile drops, the bank is generally able to apply a discount to our client’s loan.
Yep, all part of the free ongoing post-settlement service Mint Equity provides to all our clients.
5. ‘Rate lock’ your interest rate
As the threat of interest rate increases gain more traction, there is the chance that the interest rate can increase between the loan application process and settlement. Normally you’ll get the interest rate that applies on the day your home loan is settled, which could be different to the rate available on the day you first applied.
That’s where ‘rate lock’ is a good option if you are concerned the fixed interest rate will increase before you even sign the loan agreement. Generally speaking, if you request a ‘rate lock’ the lender will honour the advertised fixed rate for up to 90 days before your home loan settlement date.
Keep in mind there is usually a fee to apply the ‘rate lock’ to your application, and with some lenders taking a long time process application, this may be a good option to reduce the risk of an interest rate increase.