Economists in Australia are almost certain that the Reserve Bank of Australia (RBA) will announce a rate rise, probably as early as May 3, after new data revealed the consumer price index rose by 5.1% in March.
According to a news report, of the 21 economists interviewed, 13 anticipate a 15 basis point increase to 0.25%, similar to money markets; 5 foresee a supersized 40-basis-point hike to 0.5%, and the remaining think it will “stand pat.”
Some anticipate that the RBA will hike the rates after the federal elections in June when it receives the March quarter Consumer Price Index (CPI), wage growth and national accounts data.
The move, when it happens, will mark the first hike in Australia’s Official Cash Rate (OCR) from its current record low level of 0.1% since 2010.
Many home buyers want to know the implications of the interest rate hike on fixed-rate and variable rate loans, home mortgage repayments, house prices and what’s in store for home buyers. Here’s a round-up of what the experts are saying about it.
How Far will Interest Rates Rise?
While Australia’s bank economists anticipate the RBA will lift the OCR in the range of 1.15% (CBA) and 2.25% (NAB), the futures market expects a massive OCR of 3.4% by August 2023. One can assume that the rise would be some point midway between these two extremes.
Let’s consider the impact of monthly mortgage repayments on a median-priced home if rates rose between CBA’s and the futures market’s forecasts, assuming a home purchase involving a 20% deposit and a 30-year principal and interest mortgage.
Should the discount variable mortgage rate increase by 1.15% as predicted by the CBA, mortgage repayments would increase by 15% from current levels, hiking monthly repayments on the median-priced home by $400.
On the other hand, if the discount variable mortgage rate rises in line with the futures market’s projections of 3.4% by August 2023, then the average mortgage monthly repayments on the median-priced Australian home would rise by almost $1250, i.e., up 46%.
What is the Situation with Fixed-Rate Loans?
According to the Australian Bureau of Statistics (ABS), the share of fixed-rate loans fell from 46% in July 2021 to 28% in February 2022.
However, it may be too early to decide if any short-term jump in fixings would be feasible as per industry sources.
Australia’s leading banks still offer variable rate loans averaging 2.14% as compared to three-year fixed loans of more than 4%,
So, if you are in good financial space to make the extra payment or plan to refinance or sell your home, you may do better staying on the variable rate. But, if you find the prospects of the interest hike overwhelming and stressful, then shifting to a fixed rate may ease the pressure.
Markets typically drive the RBA cycle, and banks have been raising fixed rates since October. One contributing factor was the end of the RBA’s term funding facility in June. It was created to ease the impact of Covid on the economy and allowed banks to borrow at a rate of 0.1% for up to three years, underpinning the low, fixed rates.
The fixed rates also reflect the markets’ anticipation of more tightening by the RBA. For example, the country’s third-largest home loan lender, the National Australia Bank, has hiked fixed rates four times in 2022. This includes increasing the rate on a standard 5-year loan to 4.99%, i.e., up by half a percentage point.
According to industry sources, some loans have increased almost three percentage points in less than a year.
In short, if you are on a fixed-rate home loan, you’ll be pretty insulated from any immediate rate rise. However, it may get problematic when you seek to refinance on the expiry of your loan tenure.
What is the Outlook for Variable Loans?
The high competition between lenders will ensure that variable loans can still be provided at sub-2% annual rates. Also, with refinancing options available, homebuyers can still net some good variable rate deals.
Further, depending on the loan amount, higher rates will have a varying degree of impact across the country, depending on the wages and mortgage size. For example, a place like Sydney, which has the highest median prices, could witness the steepest hike in repayments.
However, the RBA, in their April financial stability review, highlighted that the median repayment buffer for variable rate mortgage owner-occupiers had risen from 10 months (when the pandemic began) to 21 months of scheduled repayments in February 2022.
So if the interest rates increase by two percentage points, the median repayment buffer would only be cut back to 19 months, which is still considerable.
Experts feel that the central bank may not yet press panic buttons about the capability of most mortgage holders to take on the repayment. Considering that the median household is encouragingly ahead of their mortgage repayments, the risk of defaulting on repayments is diminished.
If you are less of a risk-taker but would be happy to have some flexibility, then going for a split mortgage with fixed and variable rates components may work best for you.
How Much Could Mortgage Repayments Rise for a New Owner-Occupier Borrower?
If you Bought Before the Pandemic
You don’t need to stress. However, the rising new home prices and stagnant incomes signal that the loan component in your income is relatively more significant than during previous years when the rates increased. In most cases, your interest payments will return to the pandemic-era rate levels.
Additionally, if you used the past two years to make the same repayments even after a drop in interest rates, you would now be ahead on your mortgage repayment.
RBA is confident that Australian home buyers are well-placed to absorb interest rate hikes, with many having a repayment buffer of almost two years, up from just ten months at the start of the pandemic.
In general, interest payments presently account for just 4% of the total disposable incomes of Australians. Even with an interest rate rise by two percentage points, interest repayment would still account for less than 8% of your income– similar to pre-covid June 2019 levels.
Interest rates would have to rise to an average mortgage rate of more than 7% (up by four percentage points) before they would return to the peaks as a share of total household income, which they had touched just before the 2008 global financial crisis. These numbers suggest that the spending power of home loan borrowers won’t be hit as severely.
Recent Home Buyers
Buyers who recently bought a home and borrowed maximum are vulnerable because of higher interest rates.
According to ABS data, the average size of new housing loans has increased by over 20% over the last two years alone. They reached a high of $605,000 in December 2021.
Almost 25% of the new buyers have borrowed loans more than six times their annual incomes. This group is likely to feel the heat, dealing with big loans and higher interest rates.
If their property prices drop, they face the possibility of negative equity for their home.
Nevertheless, some economists predict that high household debt will make borrowers extra sensitive to rate rises, and many households will start nipping spending as interest rates begin to normalise.
How Much will Australian House prices Fall if Interest rates Increase?
Most Australian home loan borrowers are concerned about what happens to the value of their property as interest rates rise.
RBA, in its latest Financial Stability Review, released earlier this month, estimated “a 200 basis point increase in interest rates from current levels would lower real housing prices by around 15% over two years, relative to the baseline model projection in the absence of an interest rate shock.”
Since most buyers had expected the interest rates to hover low for some more time, the long-term impact could be more significant.
A drop in the value of house prices may make homeowners feel poorer and reduce their spending at a higher rate than the impact of the rate increase.
Is Refinancing a Good Idea?
With all indicators hinting at increasing rates, it could now be a good opportunity for mortgage holders to look for refinancing and benefit from low-interest rates. It may help you save on loan repayments and put you on the fast track to homeownership.
The feasibility of switching to a new loan, i.e., refinancing, depends on the current interest rate because changing at any point will help you save a lot.
If you haven’t refinanced for some years and are on a high rate, for example, your interest rate starts with a ‘3’ or a ‘4,’ then you’ll most likely be able to save money from the day you switch.
Consider the following case. If you refinance a 20 year, $400,000 loan, switching from a rate of 4% to 3%, you would be able to save around $2466 annually, which means a saving of nearly $49,327 over the life of the loan.
Refinancing, when done wisely, can offer you other benefits such as helping debt consolidation, access to home equity for home renovation or investment purposes, and access to redraw or flexible repayments options.
Cashback
In recent years, the highly competitive home loan market has seen a massive rise in the number of cashback offers by different lenders, many of which are in the range of $2000 - $4000.
Experts feel that the cashback option would be obvious if you’re down to choosing between two loans with comparable rates. At the same time, homebuyers should be aware of the interest rate they’re offered. A competitive rate will save you much more than any cashback offer in the long term.
Going by trends, cashbacks are generally between $2000 and $4000, which though a lot, may not be as cost-saving as switching to a competitive interest rate where, depending on what your old rate was, you may now be able to save $2000-$3000 in a year.
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