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 it could be anticipated that there may 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 for 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, in May 2022, following a sharp increase in inflation, the Reserve Bank of Australia announced a 0.25% increase in their Target Cash Rate, and flagged that further increases could be expected as they commence winding back the favourable monetary support put in place during the pandemic.

In his March 2022 statement, Philip Lowe, governor of the Reserve Bank of Australia noted that things such as the war in Ukraine, increasing energy prices and disruptions to global supply chains are pushing up inflation rates in many parts of the world, including Australia.

Combined with the declining unemployment rate in Australia, and evidence of wages growth, the Reserve Bank Board have decided to increase interest rates to help stem the increase in inflation. We have also seen the fixed rate interest market increasing in recent months. One example of that is Westpac’s owner occupier 3-year fixed rate increasing from 3.19%pa in December 2021 to 4.04%pa in March 2022. This is an increase of .85% or 85 basis points in just 3 months.

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 of 3.29% per annum then currently monthly repayments would be $2,188. An increase of 0.25%, as announced by the RBA in May 2022, would increase those repayments by $69 dollars a month to $2,257 … or roughly $800 a year.

This would be manageable for many people, however if interest rates continue to rise as predicted, then that would increase repayments by more than $5,000 a year. 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 salaries, 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 $2,275.

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%, would take their home loan repayments from $2,275 per month to $2,726. That extra ~$500 per month would put some serious pressure on their budget; especially in light of the fact that purchasing a home meant moving further away from their jobs which meant they also needed to buy a 2nd car.

To keep their monthly repayments at around the $2,300 mark, at an interest rate of 4.79%pa, their loan amount would need to reduce to approximately $440,000 - meaning they need to save another $80,000 for their $650,000 home or consider purchasing a home for the reduced amount of $570,000; or do something in between. A tough call when you’ve been working so hard towards buying your first home.

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 go up. 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 shows a $500,000 loan repayable over 30 years at a rate of 3.29%pa with minimum monthly repayments of $2,188. By making repayments of ½ the monthly repayment, that is $1,094 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 almost 4 years off the loan and save nearly $40,000 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 3.29%, with repayments of $2,188 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 usually 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 could be upon us before the end of the year. 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.