Here’s how to mitigate the effects of rising interest rates on home loans
In recent years, mortgage borrowers have grown accustomed to interest rates that would have seemed unimaginable a decade ago.
In May 2011, the new two-year average fixed rate was 6.45%. Last month it was 3.46% and banks are offering special offers of 2.55%.
But there are warnings that the good times of cheap money may soon (sort of) be coming to an end.
The Reserve Bank this week left the official exchange rate (OCR) at 0.25% as expected, but signaled that the rate would start to rise at the end of next year and reach 1.75% by mid-2024.
What does the official exchange rate mean?
* SBA raises longer-term fixed interest rates on home loans as economies begin to recover
* ASB economists: Rolling sets best mortgage strategy
* Rates are below 3%, so why do banks always check that you can pay 7%?
SBA economist Chris Tennent-Brown said his team believed New Zealand was at or above the low point in mortgage interest rates. The improving economy, both locally and globally, was putting upward pressure, especially in the longer term.
But if the prospect of a rate hike worries you, what can you do?
Anticipate your payments
Mortgage broker Glen McLeod of Edge Mortgages said people could avoid the effect of future rate hikes by making extra payments on their mortgages now when rates are still low.
He had recently handled a case where a borrower had set a combination of one- and two-year rates and opted for payments $300 a month higher than they were supposed to be. Under current rate parameters, this would save them $45,000.
It would also mean that any future increase in payments due to higher interest rates was not such a jump.
McLeod says any extra you can afford to invest in their home loans will make a difference. “Even $20 a week or $20 a month will still save you money.”
Think about your strategy
If you’re taking out a new loan or the end of a fixed term is approaching, you’ll need to think about what type of structure is right for you going forward.
Interest rates range from 2.25% for one-year terms to approximately 3.5% for five-year terms.
McLeod said he heard from many worried borrowers. But he said he pointed out that most forecasts are that short-term rates won’t rise significantly for about a year.
“Do you feel conservative or a bit more optimistic? Are you willing to lock in for 12 months to get another cheaper short rate to go with you, or do you want a long term rate where you know where you are?
“[Those questions] tend to take them to their own conclusions and go short term.
Mortgage adviser Bruce Patten of Loan Market agreed that short-term rates are likely to remain low for at least a year or two.
“If you want the security of knowing your costs now, it might be time to consider fixing for a slightly longer period, but if your income is high and you’re confident in your earning power, rates in the shorter term will allow you to pay off your debts much more quickly.”
You can also divide your mortgage into a number of smaller loans and fix some for short term and some for longer term. If you have fixed half for two years, one quarter for three years and one quarter for one year, you never have an entire loan running out at a time when interest rates might not be in your favor.
Tennent-Brown said taking the cheapest short terms and rolling them over was still likely the cheapest option over a five-year horizon.
“Borrowers are cautious and plan to face higher interest rate costs, rather than budgeting for rates to stay this low indefinitely. And for those who want interest rate certainty now, the cost of Longer-term fixation is very low compared to the past, with current rates around 3%”.
Infometrics chief economist Gareth Kiernan said people have already missed the best rates for longer-term solutions. “Four- and five-year rates look a bit pricey, even taking into account rising interest rates.”
But he said some might see the value of securing longer, even at a higher rate, if it gave them certainty of what their mortgage payments would be.
“My recommendation would be the three-year rate at 2.7%. Three years is a reasonable amount of time to be able to prepare for what might happen next.
Are you worried about missing something?
If you’ve been waiting for a longer fixed term to get a super cheap rate, you might be worried that you’re missing out.
It is possible to break a fixed term loan, but there will usually be a fee. Depending on how long you’ve been patching and how long it’s left to run, it can be quite expensive.
Banks calculate the cost by considering how long the remaining term is and how much they can charge someone else for that money.
Usually, if you intend to save a lot of money, you will also have to pay significant fees, but a mortgage adviser or a bank can help you.
If you fixed a short-term loan but have since decided that a longer fix would be better, there’s usually no charge for breaking a loan and moving to a higher rate.
Houses cost much less, but in previous decades mortgage interest rates were much higher.
Pay off other debts
Although your home loan rates are low, this is an opportunity to use the extra money in your budget to pay off other loans. This will put you in a better financial position overall and will mean that, if you are disciplined, your income will be greater to meet home loan repayments, should rates rise.
Remember that your bank has probably already verified it
When banks assess borrowers’ applications, they compare them to higher rates than most people pay.
The rates used for this process vary but can range from approximately 3.2% to 6.3%.
Chances are your bank has already considered the possibility that you might have to pay a higher rate in the future and has determined that you can afford it.
Kiernan said rates were unlikely to return to the 10% or higher of 2008.
Most forecasts would place floating rates at a high of around 6.5%, he said.
If you’re still worried, McLeod recommends contacting a mortgage advisor. “That’s what we’re here to do.”