The impact of increasing interest rates.

Hi, I’m Bronwyn Lawson from Westpac’s Davidson Institute. Here to talk to you about the impact of rising interest rates. In this video I’ll purely be looking at interest rate rises as it impacts home loans but there is likely to be broader impacts across other finance products too.

The information contained in this presentation is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information to your own circumstances and, if necessary, seek appropriate professional advice.

Over the past 10 years, Australia, and indeed many other parts of the world, have enjoyed a low interest rate environment. However, a global increase in inflation, due to things such as the war in Ukraine, increasing energy prices and disruptions to global supply chains, has seen this come to an end and Australia’s Reserve Bank Board have acted to increase interest rates to help stem the increase in inflation.

In May 2022, the Reserve Bank of Australia announced the first of a number of increases, bringing the current cash rate target to 3.35%. It’s also anticipated that this may continue to rise in the coming months as inflation continues to rise and the Reserve Bank winds back the favourable monetary support put in place during the pandemic.

So, how much difference does an increase in rates affect home loan repayments? If we have a look at the impact on a $500,000 home loan being repaid over 30 years at Westpac’s current standard variable rate … back in May the repayments would have been approximately $2,558; at the current variable rate of 6.29%pa the new repayments would be approximately $3,092 per month, an increase of over $6,000 a year.

Should rates continue to rise, then a further 1%pa would again push repayments up by nearly $4,000 a year.

The difference in repayment amounts from May 2022 to the 3rd scenario is close to $900 a month … or as I heard someone say “that’s like the equivalent of buying a new washing machine every month”. So, anyone in the market for a new home, or those with an existing home loan, it would be advisable to start thinking about how interest rate increases could affect your home affordability and consider these repayment increases in your budget.

So, what are some of the things we can do to manage this rising cost. Firstly, new home buyers may need to revisit their anticipated purchase cost on a new home. Let’s look at an example of what I mean by that.

Our case study couple, Jac and Dan, are in the market for their first home and have been seriously saving for their home deposit for the last few years. With both of them earning reasonable incomes, they have been looking for a home to buy at around $650,000 and have been able to accumulate a 20% deposit of $130,000. This would mean that their home loan would be $520,000 with monthly repayments of $3,287 at a rate of 6.5%pa.

Having heard that interest rates may be increasing, they wanted to see what this meant for their repayments, and found that an interest rate increase of 1.5%pa, that is to 8.0%pa, would take their home loan repayments from $3,287 per month to $3,816. That extra $500 per month would put some serious pressure on their budget.

To keep their monthly repayments at around the $3,300 a month mark, their loan amount would need to reduce to approximately $450,000 - meaning they need to save another $70,000 for their $650,000 home. Or they may decide to purchase a home for the reduced amount of $580,000; or do something in between. A tough call when you’ve been working so hard towards buying your first home, but a reality in a rising interest rates environment.

Another thing we could do is to look for ways to reduce other costs. This could be things like checking your utilities providers to see whether you can get a better deal. Take a look at your lifestyle and see where you may be able to find some savings.

A couple of tools to help you do that … are our cost-cutting checklist on the Davidson Institute website … which is some simple thought prompters on where you might look for savings. Or you could try out the Spend Snap Shot tool, also from the Davidson Institute website, where you can record all your income and expenses to see where your hard-earned cash really goes.

It would be helpful to take a holistic look at your debts to see where you could potentially make some reductions before the rates increase further. You might consider refinancing to a lower rate loan. You could also think about locking into a fixed rate – even if they’re a little higher than the variable rate at the moment. That way you could be comfortable knowing that your repayments are fixed for the term you lock in for rather than increasing when rates change.

Another option for some is to accelerate repayments to reduce interest costs. It’s quite significant the difference it can make to make fortnightly repayments, or, where possible, to make higher repayments than required.

Starting with making fortnightly repayments … the graph on the screen, which is from the Westpac Home Loan calculator, shows a $500,000 loan repayable over 30 years at a rate of 6.00%pa with minimum monthly repayments of approximately $2,998.

By making repayments of ½ the monthly repayment, that is approximately $1,499 on a fortnightly basis, we can reduce the overall term of the loan and the interest costs. On this repayment amount and frequency, you could potentially shave more than 5 years off the loan and save over $120,000 in interest costs

The time and interest savings are generated because the more frequent repayments reduce the principal amount more quickly, which reduces the interest that is calculated.

Another option for some is to make repayments higher than the minimum required amount. Again, this has the effect of reducing the principal more quickly, and thus the interest calculated too.

The example on the screen shows the same loan amount of $500,000, at the interest rate of 6.00%pa, with repayments of approximately $2,998 over 30 years. By paying an additional $100 a month, roughly $25 a week, again the savings in terms of time and interest are significant. If you’re able to squeeze some extra repayments out of your budget, it’s worth it in the long run.

If you’re going to make additional repayments though, check whether your loan has a “redraw” facility that will allow you to retrieve those extra repayments should you need to.

Remember too though, that if you decide to fix your interest rate, you may not be able to make more frequent or additional repayments without incurring penalties. Make sure you check before changing your repayment arrangements.

So, there are some options that may be helpful managing increasing repayments due to increasing interest rates. This list is by no means exhaustive but is intended to be a thought and action prompter for you to prepare for interest rate increases that are well and truly upon us.

I’d encourage you too, to give careful consideration to any changes that you intend to make and strongly advise discussing your situation with a finance professional.

Thank you for watching ‘The impact of rising interest rates’’. I hope you found this information helpful, and I encourage you to check out the other webinars and resources on the Davidson Institute website to help build your financial confidence. Bye for now.