Home loan interest rates are on the rise again. Homeowners and first home buyers may be wondering if now is the right time to fix their interest rate, or if a variable rate loan may be a better fit in 2022?
Whether your fixed rate period is coming to an end and you’re unsure whether to re-fix or refinance, or you’re in the market for your first home loan and don’t know which option is best, there’s a lot to consider in a higher rate environment.
There are advantages to both fixed and variable rates even in 2022, and ultimately it comes down to knowing which option suits your budget better and starting with a lower rate to begin with.
Let’s explore what influences interest rates to fluctuate, the benefits and disadvantages of fixed rates and whether locking in your rate is still a good decision in 2022.
The benefits and risks of a fixed rate mortgage
The main benefit of a fixed interest rate is that it locks in your home loan rate for a set period of time – typically one to five years. When interest rates rise, as they have in 2022, your mortgage repayments will not increase throughout the fixed period. You are protected from rate changes.
A fixed rate home loan also offers you more stability in your budgeting, as your repayments will not change for the duration of your fixed period. If you’re the type of person who likes to know exactly how much to budget for expenses each month, a fixed home loan rate could provide that certainty and peace of mind for your household.
When a fixed rate period ends, the interest rate typically reverts to the lender’s standard variable rate, unless you consider refinancing or re-fixing. This tends to be a higher interest rate – especially in a rising rate environment.
Comparatively, a variable rate home loan is subject to market fluctuation. When the cash rate rises, your lender will generally pass on this hike to your interest rate. However, helpful features homeowners use to reduce their interest and repayments, like an offset account or making additional repayments, are typically found with variable rate loans.
Pros of fixed rates:
- Avoid impact of interest rate fluctuations
- Simplified budgeting as repayments don’t change
Pros of variable rates:
- More likely to gain access to features, like an offset account or redraw facility
- If rates fall your repayments should reduce too
Why are interest rates on the rise?
To help you make an informed decision around whether or not to fix your interest rate, it’s important to understand what influences interest rates in the Australian home loan market.
Interest rates are currently on the rise due to the Reserve Bank of Australia (RBA) hiking the official cash rate for the first time in 11.5 years. The cash rate is the interest rate charged on unsecured overnight loans between lenders. It is an influential benchmark rate that lenders use to help determine their loan rates, as well as rates on savings accounts and term deposits.
On the first Tuesday of every month (excluding January), the RBA meets to set the cash rate. The decision is based on macroeconomic factors, such as inflation, wage growth and unemployment.
In May 2022, the RBA hiked the cash rate for the first time in over a decade, mainly due to higher than expected annual inflation. The theory is that when cost-of-living pressures are rising faster than expected, increasing interest rates makes consumer and business access to credit, like loans, more difficult.
When Australians are less likely to borrow funds because of higher rates, spending decreases. And if spending decreases, this should put downward pressure on economic growth and inflation.
If you’re tossing up whether to fix your interest rate or not, it’s important to follow the news and do your research around influential measurements that lead to interest rate rises, like inflation. If these factors are rising or falling more than expected, it can affect the RBA’s decision.
Keep in mind that home loan lenders can choose to cut or hike their interest rates out-of-cycle with the RBA. But the cash rate is arguably one of the most significant factors influencing how your home loan interest rate moves.
How high could interest rates climb in 2022?
RBA Governor Philip Lowe has suggested inflation could hit 7% by the end of the year, which means more cash rate increases are expected in 2022. If you are currently paying a variable rate home loan or are considering fixing, you may be wondering how high could the RBA hike the cash rate this year.
Economists have been debating this for some time, with the general consensus seeming to suggest that the cash rate could peak at around 2-3% by December 2022. Some experts believe it could reach 3.5% by mid-2023, so it’s safe to say that it will continue to rise for some time.
Unfortunately, it is too late for homeowners and first time buyers to lock in the sub-2% interest rates on offer last year. Even homeowners who are locked into these lower interest rates may have their fixed rate term coming to an end soon, and will be entering a higher-rate environment. So, what do you do today when rates have already increased?
To fix or not to fix?
Firstly, look at how experts have forecast the cash rate hike to move. Experts have suggested it could reach around 3.0% by December.
This is an increase of 2.9 percentage points from where the cash rate started at 0.10% in April in less than 12 months. If your home loan rate was, for example, 3.5% in April, ask yourself if you can afford to make monthly repayments that are 2.9 percentage points higher at 6.4%. A Mortgage Repayment Calculator could come in handy here.
If the answer is no, you may want to consider comparing your options and looking for a fixed rate that sits around what you can comfortably repay. It will not be too late to fix your rate if you find a lower-rate option that better suits your budget. Keep in mind that leaving a fixed loan term early can result in paying expensive break fees.
Alternatively, if you prefer variable rate home loans, or are not comfortable locking in a rate in the current environment, still consider comparing lower rate options. If you start with a lower rate to begin with, your home loan repayments may be better protected from inevitable rate hikes.
This may involve looking outside of the traditional big banks, as competitor lenders generally offer lower interest rates on average. In fact, Reduce Home Loans has consistently broken records in Australia by offering lower rate home loans to everyday homeowners.
We currently offer one of the lowest rates available for refinancers with our Rate Cutter Variable Home Loan (60% LVR) at 2.49%. And for new home purchases, you may be eligible for the Rate Lovers Cash Back home loan at 2.99%.
Further, a variable home loan may allow you to utilise features that could protect your repayments against rising interest rates. The funds you deposit into an offset account may be used to reduce the amount of interest charged on your home loan. And any extra repayments you make will chip away at your loan’s principal, and reduce your loan amount owing. Of course, home loans with features typically come with higher interest rates than ‘no-frills’ basic options, so be sure to compare interest rates.
What to consider:
- It’s not too late to fix if you do your research around the cash rate hike forecasts and find a lower rate that suits your budget.
- You may be charged break costs for leaving a fixed rate term early.
- If you prefer variable rate loans, consider a sub-3% interest rate now so inevitable rate. hikes don’t peak too high for your budget.
- Variable rate loans generally offer features that help lower repayments and interest, but can come with higher interest rates.
Split the difference
If you’re still unsure whether to opt for a fixed or variable rate, it may be worth considering splitting the difference with a split rate home loan.
As the name suggests, this involves dividing a percentage of your home loan repayments to a fixed interest rate and a variable interest rate. It doesn’t have to be a 50/50 division either, as you could choose to fix 70% of the mortgage and leave 30% on a variable rate.
Splitting your home loan rate could offer the ‘best of both worlds’ for some borrowers who want the benefits of certainty in your repayments from a fixed rate, but also want features typically reserved for variable rate loans. When interest rates rise, only a portion of your repayments will increase, so the impact may not be as significant as a 100% variable rate. And if interest rates do fall again, your home loan that is on a variable rate will fall as well, lowering your repayments.
It’s fair to say that the days of home loan rates starting with a ‘1’ may be over for now. With interest rates on the rise in 2022, homeowners and would-be buyers could consider prioritising low rate home loan lenders regardless of the rate type they choose.
To speak to one of the experts at Reduce Home Loans to learn more about our lower-rate mortgages, don’t hesitate to call us on 1300 733 823.
Any statements are general in nature and do not take into account your financial personal situation, objectives or needs. You should consider whether any statement/s is suitable for you and your personal circumstances. Before making any financial decision, consider your circumstances and the product disclosure statement.