Rising interest rates are almost always portrayed as bad news, by the media and by politicians of all persuasions. But a rise in rates cuts both ways.
Higher interest rates are a worry for people with home loans and borrowers generally. But they are good news for older Australians who may depend on income from bank deposits and young people trying to save for a deposit on their first home.
Rising interest rates are also a sign of a growing economy, which creates jobs and provides the income people need to pay the mortgage and other bills. By lifting interest rates, the Reserve Bank of Australia (RBA) hopes to keep a lid on inflation and rising prices. Yes, it’s complicated.
How high will rates go?
In May, the RBA increased the cash rate target for the first time since November 2010, from its historic low of 0.10 percent. The reason the cash rate is watched so closely is that it flows through to mortgages and other lending rates in the economy.
Last week (Tuesday 7 June) the RBA raised the cash rate for a second month in a row, from 0.35 to 0.85 percent.
To tackle the rising cost of living, the RBA has indicated it would not be unreasonable to expect the cash rate to be lifted further, to around 2.5 percent.i Inflation is currently running at 5.1 percent, which means annual wage growth of 2.4 percent is not keeping pace with rising prices.ii
So, what does this mean for household budgets?
Mortgage rates on the rise:
While the big four banks are not obliged to pass on the cash rate changes, in May they passed on the RBA’s 0.25 percent increase in the cash rate in full to their standard variable mortgage rates, which range from 4.6 to 4.8 percent. The lowest standard variable rates from smaller lenders are below 2 percent.
Consequently, homeowners on variable rate loans are likely to already be paying more each month in interest rate payments. For example, someone who had a 3 percent per annum variable interest rate, on a 25-year term, on the average home loan amount of $611,524 – would be paying $80 more per month, prior to last week’s announcement.
Should lenders increase variable interest rates in-line with this month’s cash rate increase (June), the homeowner in the above example – could be paying $244 more per month than before the two cash rate increases.
The people most affected by rising rates are likely those who recently bought their first home. A twofold blow, after several years of booming house prices – the size of the average mortgage has also increased.
According to CoreLogic, even though price growth is slowing, the median home value rose 16.7 percent nationally in the year to April to $748,635. Prices are higher in Sydney, Canberra and Melbourne.
CoreLogic estimates a 1 percent rise would add $486 a month to repayments on the median new home loan in Sydney, and an additional $1,006 a month for a 2 percent rise.
However, it’s believed most homeowners should be able to absorb a 2 percent rise in their repayments.iii
The financial regulator, APRA now insists all lenders apply at least 3.0 percentage points on top of their headline borrowing rate, as a stress test on the amount you can borrow (up from 2.5 percent prior to October 2021.)iv
Rate rise action plan:
Whatever your circumstances, the shift from a low interest rate, low inflation economic environment to rising rates and inflation, is a signal that it may be time to revisit some of your financial assumptions.
The first thing you need to do is update your budget to factor in higher loan repayments and the rising cost of essential items such as food, fuel, power, childcare, health and insurances. You could then look for easy cuts from your non-essential spending on things like regular takeaways, eating out and streaming services.
If you have a home loan, then potentially the biggest saving involves absolutely no sacrifice to your lifestyle. Simply pick up the phone and ask your lender to give you a better deal. Banks typically offer lower rates to new customers than they do to existing customers, but you can often negotiate a lower rate simply by asking.
If your bank won’t budge, then consider switching lenders or call our Debt Analysis Team (DAT) for a review. With access to a panel of over 60 lenders, we can compare your current loan and help determine whether you could be moved to a more competitive deal.
The challenge for savers:
Older Australians and young savers face a tougher task. Bank savings rates are generally non-negotiable, but it does pay to shop around.
The silver lining is that many people will also see increased interest rates on their savings accounts as the cash rate increases. By mid-May, only three of the big four banks had increased rates for savings accounts. Several lenders also announced increased rates for term deposits of up to 0.6 percent.v
High interest rates traditionally put a dampener on returns from shares and property, so commentators are warning investors to prepare for lower returns from these investments and superannuation.
That makes it more important than ever to ensure you are getting the optimal return on your savings and not paying more than necessary on your loans. If you would like to discuss a budgeting and savings plan or review your home loan or any other debts you may have, please give our DAT a call.
i https://www.rba.gov.au/speeches/2022/sp-gov-2022-05-03-q-and-a-transcript.html
ii https://www.abs.gov.au/
iii https://www.canstar.com.au/home-loans/banks-respond-cash-rate-increase/
iv https://www.apra.gov.au/news-and-publications/apra-increases-banks
v https://www.ratecity.com.au/term-deposits/news/banks-increased-term-deposit-interest-rates