Earlier in November, we saw the Reserve Bank of Australia (RBA) signal the potential for the cash rate to rise sooner than expected. While the rate remained at its historic low of 0.10% for the 12th consecutive month, the RBA conceding its long-held forecast of no rises until 2024 could pave the way for home loan price hikes in the near future.
This may cause concern for some current mortgage holders – the RBA’s cash rate acts as a benchmark by which banks and lends set and shift their own rates.
If you’ve locked in a competitive fixed interest rate, it’ll hold steady for whatever term you agreed to, but you could face more expensive rates once that time is up. For property owners with a variable home loan, you might see changes sooner. Whatever kind of loan you hold, it’s worth comparing home loans as the situation develops to ensure you’re in the best position for your financial future.
But what if you’re just about to jump on the property ladder? Is there a right or wrong route to take when it comes to choosing a home loan in the current market? Let’s explore…
Fixed or variable – that is the question
Peter Marshall is the Banking Expert from financial comparison site, Mozo. He says banks and lenders have been anticipating this kind of move by the RBA, and were increasing fixed home loan rates well before the latest meeting statement.
“The RBA’s recent actions make it likely that the pace and size of rate increases will pick up over coming weeks and months,” Marshall says.
“We are likely to see banks and lenders trying to keep their short-term fixed rates and variable rates down, but anything two years or more is likely to be going up fairly soon.”
There have been 508 fixed interest rate rises recorded in the Mozo database since the RBA meeting on November 2, with the majority of price hikes seen across 3, 4 and 5-year terms.* This is in contrast to only a handful of fixed rate reductions. Currently, the average 4-year fixed rate in the Mozo database sits at 2.75% p.a.* (up from 2.37% p.a. in March 2021).
Meanwhile, cuts to variable rates have accelerated in recent months, and Mozo recorded another 71 variable rate reductions just since the RBA meeting, and no rate rises. Marshall says this provides some evidence of lenders trying to steer customers away from their still attractive fixed rate options.
“Variable rates should remain low for quite a while yet, but by the time they do start to increase, fixed rates will probably be much higher than they are now,” he says.
Can a certain home loan type help you get into the property market?
Beyond interest rates, there are other mortgage features which can help you save money and get into the market sooner.
Firstly, avoid any start-up or ongoing home loan fees. Application, valuation, legal and service fees can add up. A good way to clock these is to look at comparison rates – this number signals the ‘true’ cost of the loan, as it takes into account these fees as well as interest.
Then, consider money-saving features which might suit your financial circumstances. If you’ve got some savings sitting idly by or need somewhere to deposit your monthly pay cheque, look out for a home loan with an offset account. This operates just like a transaction account, but the money sitting in it will reduce the home loan amount you pay interest on by that balance.
Or, consider a mortgage offering fee-free extra repayments and redraws. By making additional repayments on your loan when you’ve got the cash to spend, you can pay less in interest and potentially rid yourself of your mortgage sooner. Redraw facilities allow you to dip back into that pool of funds if necessary (again, free is best).
Choosing between a fixed and variable home loan
There are pros and cons connected to either choice.
A variable mortgage will often provide more flexible money-saving features and comes at slightly lower interest rates right now, but this could change if rates rise (which is looking more likely).
While a fixed home loan may not offer all these features, it ensures your repayment schedule for those first few years if your budget is tight and you can lock in a good rate (for a set period) in uncertain times – but it does mean you won’t benefit from interest rate reductions.
Marshall says a split home loan can be a happy medium, letting you take advantage of both options and hedge your interest rate bets by putting portions of your loan under variable and fixed conditions.
“Every borrower needs to consider their current and long-term financial needs – as well as the state of the home loan market – to make a decision about choosing a fixed or variable loan right now. Taking the split loan approach could be a good way to hedge rate risks during this period.”
Whatever home loan road you take, it’s essential you research your mortgage in the same way you’d carefully inspect a property – both may be your everyday companion for some time.
The revised mortgage stress test
Once you get to the point of applying for a home loan, you need to prove you have the ability to actually pay it back. This is known as your home loan serviceability.
To determine this, banks and lenders conduct a stress test to see if you can meet mortgage repayments at a higher interest rate than what’s being offered to you. This is to ensure you don’t experience financial hardship or default on the mortgage should interest rates rise.
In an effort to curb increasing debt-to-income ratios and potential risky lending, the Australian Prudential Regulation Authority (APRA) has tightened serviceability requirements.
According to APRA’s lending data, high-debt home loans have seen considerable growth recently. Borrowers who took on home loan debt in the June quarter that was at least six times greater than their annual income jumped from 16% this time last year to almost 22% in 2021.
Banks and lenders are now required to add at least a 3.00% buffer (previously 2.50%) on top of the offered rate to account for potential rate hikes when calculating a borrower’s ability to service a home loan. This could effectively make it more difficult for some types of borrowers to take out a mortgage.
While it isn’t the responsibility of the RBA or APRA to influence housing affordability, this move may have a flow-on effect in curbing the record-breaking property price growth we’ve seen in Australia over the last few years.
Effectively, if every potential buyer is facing stricter lending requirements and potentially not being able to borrow larger amounts, the property market could respond with a gradual easing of price growth.
These kinds of adjustments to lending requirements are a long-term game, so when it comes to potential property price shifts, only time will tell.
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