ANZ

Coping with rising rates – the rate cycle explained

Home loan interest rates are rising. We explain the interest rate cycle and suggest ways to manage with higher rates.

Borrowers should plan for higher interest rates this year as the Reserve Bank moves to rein in Australia’s booming property market and control economic growth.

ANZ Bank senior treasury economist David deGaris, says more rate rises are inevitable.

“We have had two rate rises this year and the market is expecting that by the end of this year, the cash rate will have increased from 4.75 basis points to between 5.5 and 5.75 basis points.”

“In May the Reserve Bank Governor went on record warning that rates could hit 8 per cent. A lot was made of this warning but I sense the Reserve Bank was simply heralding that by raising rates early and quickly, they won’t need to raise rates by as much later on,” Mr deGaris says.

A 0.25 per cent per annum rate hike will add $25 a month to the standard $160,000 mortgage over 25 years. Standard variable mortgage rates are tipped to peak at 7.55 per cent per annum in the upcoming cycle.

Why rates must rise

The Reserve Bank uses interest rates to stimulate or slow the economy and control inflation. When the global economy faltered after the September 11 terrorist attacks in the United States, the Reserve Bank quickly cut rates to stimulate spending and economic growth.

With the world economy recovering, Australia no longer needs the economic stimulus provided by low interest rates. On the contrary, the Reserve Bank is concerned that continuing low rates will over-stimulate the buoyant residential property market resulting in a boom-bust cycle. Fears of a property price boom will be a key factor in determining the size and speed of rate rises.

Other factors this year will include:

• Inflation - Whilst the rising Australian dollar is good news, inflation remains near the top of the Reserve Bank’s target range.
• Unemployment – Low unemployment is a further sign of economic recovery. It has fallen to 6.3 per cent and may fall below 6.0 per cent later this year.
• Household debt – Household debt is at record levels, largely due to bigger mortgages. The upside is that even a small rate hike will have a much bigger impact than in past cycles.
• Economic growth – With an annual growth rate of 4.0 per cent Australia is one of the western world’s fastest growing economies.

Protect yourself against rising rates

Prudent borrowers should take stock of their finances now and take steps to reduce their debt. Here are some tips for coping with rising rates.

1. Review your loan – Now is a good time to take stock of your home loan. Does it have all the necessary features you need to cope with higher repayments? Does it suit your current and near-term life plans? You may wish to consider a fixed term loan, or a split home loan i.e. part of the loan is a fixed rate loan and the other part is variable. While it may be too late to lock in for the long-term, fixed loans can offer certainty in times of change.
2. Consolidate, reduce debt – Pay off as much consumer debt as possible. Consider restructuring your finances by consolidating your debts into the one flexible loan. This goes for home owners and buyers alike.
3. Save the biggest deposit you can – The bigger your deposit, the smaller your home loan. Stick to a budget and be disciplined about savings. Even small steps like asking for a longer settlement can help you build a larger deposit. Pay costs like stamp duty, loan fees and inspection reports upfront.
4. Pay more, pay more frequently – If you have a variable home loan, pay more from the start. Switch to fortnightly repayments and put lump sum payments like tax returns or share dividends directly into your loan account.
5. Plan for larger repayments – Budget for repayments at least 2.0 per cent higher than current interest rates. If you can, start making higher repayments now to build equity while rates are low and pay off your loan faster.
6. Make the most of your loan features – Put your loan to work by using features like mortgage offset and redraw. If your loan offers offset, consider using it to park your savings. It can be tax effective and can cut years off your home loan.
7. Time your home purchase – Don’t be pressured into buying a home just because prices are rising. Higher rates may cause prices to moderate later this year. Time your purchase to coincide with a slowing in the property market cycle.