It just got harder to service a home loan: Here’s what you can do

After this week’s Reserve Bank of Australia (RBA) decision to raise the cash rate to 0.35% (an increase of 0.25%), owning a home or applying for a new home loan just got more expensive. 

The interest rate rise earlier this week may only be the beginning, with anticipations of a further rate rise to come in June, according to Mozo’s banking expert Peter Marshall. 

“The RBA is keen to get a bit of normalisation into the system, and a small increase this week followed by another 25 basis point increase in June will be less alarming to people than a one-off 40 basis point hike,” said Marshall.

With some banks already publicising their decision to pass on the rates to customers in the coming weeks, including the Big Four banks, it could get even more expensive to own or finance a new home as the year progresses. 

So, what can you do to safeguard your money against further mortgage repayment increases?

For those with an existing home loan, Mozo’s home loan rate change calculator can help you quickly and easily crunch the numbers on how much your mortgage repayments will change with the interest rate rise. 

If you’re finding it’s becoming increasingly difficult to make mortgage repayments, then it may be time to consider refinancing your loan, or even comparing new home loan options with more desirable rates.

By fixing your loan’s interest rate, you are locking in a certain rate for a specific period of time. Fixing your interest rate helps keep your repayments consistent, which is great for first home buyers and those with strict budgets. 

So you might consider fixing your home loan at a time like now, amid the RBA’s cash rate increases in order to lock in a lower interest rate. However, you need to consider the advantages and disadvantages of a fixed interest loan, and that the variable rate you revert to after the term is over may be higher.

Variable vs fixed interest loans

Variable rates are determined by your lender and often shift with the RBA cash rate, which is what we’re seeing now. When rates are low, you’ll benefit from cheaper repayments, but as soon as they rise your repayments will likely rise too.

Fixed rates, as previously mentioned, lock in a rate over a period of time, which could be good when rates are rising. However, you lose the flexibility of a variable rate, not only in terms of falling interest rates but also with important factors like being able to switch home loans easily or having a 100% offset account. Also the fact that many fixed loans charge an early exit fee. Fixed rates are often higher than variable rates too.

Fixing a portion of your loan

The latest Mozo research found that only 12% of borrowers had fixed their home loan, while a larger number (20%) had fixed some portion of their loan. 

Fixing a portion of your home loan, also known as splitting, divides your loan into two separate accounts. One account will be charged at a variable rate, and the other at a fixed rate. Once the fixed period of interest ends, you’ll be reverted back to a variable rate. 

If you’re considering this option as a way to combat the effects of the interest rate rise, then read more about splitting your home loan to see if it’s the right financial decision for you.

Offset accounts help reduce the amount of interest you pay on a loan by keeping your everyday money in a bank account with your lender. 

Offset accounts are just like an everyday bank account, except that it will be linked with your home loan. 

And you can treat your offset account just like a bank account by having your salary deposited into it, setting up direct debits for bills, and even making everyday purchases with a debit card your lender supplies.  

You can opt for a 100% offset, partial offset, or discounted rate accounts.

One caveat of an offset account is that you will likely pay a monthly fee, as well as a higher interest rate.

How 100% offset accounts work for home loans

The balance you hold in your offset account is deducted from your remaining home loan principal, which ultimately brings down the amount of interest you repay on your loan. 

For example, if a homeowner has a $500,000 home loan and $50,000 in a 100% offset account they will only be charged interest on $450,000.

What is a partial offset account? 

There are two types of partial offset accounts:

• Portion of your balance. Your provider may offset a percentage of the balance in your offset account to reduce the principal of your loan and the interest you pay. For example, if Lisa signs up with a loan with a 40% partial offset facility, $20,000 of her $50,000 balance will go towards bringing down the principal. So on a $500,000 home loan, she would only pay interest on $480,000.
• Discounted rate. Another type of partial offset you may be offered is a discounted interest rate on the balance in your offset account. For instance, a home loan with a 5% interest rate that offers a 1.5% discount will mean you will only be charged 3.5% on the balance in the offset account.

If your monthly repayments are looking to skyrocket, and fixing your interest rate or opting for an offset account, you might need to consider switching to a cheaper interest rate. 

Compare interest rates with Mozo to search for a cheaper rate today!