Let’s chat about how to prepare for an interest rate rise.
Now whether you believe interest rates will rise or not – I can tell you right now you’ll be better off for reading this post.
Well even if I’m wrong (and all the experts who happen to espouse the same advice are wrong) – worst case scenario….you’ll likely pay off your home loan sooner if you’re a home owner by adhering to some of what I say.
So, better to be prepared that not right?
Now that we’ve got that out of the way – let’s get into it.
Interest rates go up and down
Now, anyone under the age of 45 has never experienced a recession in their adult lives. Fact.
That includes me, most likely you and a majority of other mums reading this post too.
We have no reference point for it. We have lived through or witnessed the impact that a recession has on the economy and on us and those around us.
In fact, our only experience with regards to property is that house prices go up, and interest rates go down. That’s our normal.
But if we expand the time frame we look at, it’s not the norm … not even close. You see property is a market and like all markets, they move in cycles. Don’t be fooled into thinking that property is a magical asset class that only moves in one direction.
Because the truth is, we’re living through one of the greatest booms in modern history.
In fact, since 1996 we have seen the biggest run up in property prices in Australian history.
At the same time, interest rates have been in a long term downward trend for over two decades and well below their longer term average range (of between 8 – 10% pa.) for years.
Eventually it will end but nobody can accurately predict when that will be and plenty have already lost their reputations trying to guess.
I like to leave the forecasting to the economists, so you won’t read about my thoughts on time frames either!
I did a round up post on the various expert opinions here if you want to read up some more.
However, there is no point worrying about whether they will or they won’t. You’re better off just preparing for the case should they in fact climb.
If you’re looking to buy
The single biggest thing you can do at the outset of purchasing a home to protect yourself against rising interest rates is to…..wait for it…..don’t over extend yourself!
Buy only what you can afford – purchase wisely.
And don’t be suckered into believing that because you are able to borrow ‘X’ you can afford ‘X’. In this market, your borrowing capacity and your affordability are two separate measures.
Let me put it this way.
When you buy a property you take out a mortgage against that property in order to purchase it. You now owe that money to the bank.
You have an obligation to repay that debt at which point you will own the home outright.
If it is not your intention to pay off this loan in full and call this property home for the rest of your life, you are then expecting (hoping) to sell it to someone else at some point in the future for at least what you paid for it.
Now I know there are other experts out there who say that when purchasing the family home – you can’t worry too much about where the market is at given it is not an ‘investment’ in the traditional sense of the word.
Basically, you can’t sit on the fence forever waiting for a crash.
Well that may be true in the case where you buy the family home with the intention of paying off the mortgage and calling the property home forever – in which case you can ride out the fluctuations in its value so long as you can continue to service the loan.
BUT remember this, for most people, the family home is the single biggest asset they will ever own in their lifetime. For many families, their home is not their ‘forever home’ and it is costing them everything they have and then some to ‘own’ it.
Can you afford to not treat it like an investment in that case? Don’t throw all caution to the wind and purchase the house you love without doing the numbers too.
Yes, it might be the family home you’re buying and not an investment property, but are you going to be financially ‘strung out’ if circumstances change.
Is there a drop to one income coming? What if there’s an interest rate rise?
So again, my best advice for those looking to buy now would be to buy only what you can afford and price into the affordability equation at least a 2% increase in standard variable rates, or for the ultra conservatives a reversion back to long term averages of 8%.
If you’re already a home owner
The advice doesn’t really change in this case.
You would still want to be factoring in a rate increase of somewhere between 2% to 8% if you’re being conservative about it.
Those that are likely to be impacted the most are households with variable or adjustable-rate mortgages.
In short, you don’t want to put yourself at the mercy of rising interest rates when your loan begins, or continues to, adjust – up. Tight household budgets and rising interest rates are not a great combination for families.
Do some maths
Do the maths on what a potential increase of 1%, 2%, 4% etc would mean to your household cashflow.
What do the percentage increase translate to in terms of your minimum mortgage repayments & what impact does this have on your net monthly income and your ability to service your other household expenses.
If it’s negligible – which may be the case if you have a smaller loan size, then you’re unlikely to be financially troubled by an increase.
If it’s significant or it would mean that you can no longer afford to meet other household expenditure then you’re likely to have a problem.
Throw some money at it
Getting a bigger than usual tax return or company bonus? Why not consider putting some of this additional cash against your mortgage – to create a buffer and give yourself some breathing room.
If you have a redraw facility on your loan you can always access these additional funds later if there’s a financial emergency.
Or if you have a 100% offset account, put these funds into that account to help reduce the interest and therefore increase the repayment of principal that your current repayments are making.
If the family budget allows it, you could also consider making additional or increased monthly repayments for a period of time to again build in a buffer and increase your equity.
Fix your rate
You may want to consider if your lender will allow you to fix the interest rate on the balance outstanding, or at least part of the balance outstanding.
Alternatively, you could look to refinance into a fixed interest rate. At the very least, have a plan for how you will deal with potential interest rate hikes so that you’re not caught out and left financial stressed.
Don’t forget the credit card
And if you have other household debt – like credit card or personal loans outstanding, then don’t forget about these either. They are also adjustable rate financial products which basically means rates can and will go up in a rising interest rate market.
It might be time to look into attractive balance transfer rates which will can give you in some cases up to two years interest free on credit card balances – which plenty of time to start paying these debts off before rates go up.
I hear you cringe over the Wifi!! Now I don’t mean pack the kids up and sell the family home.
But if you are someone who has say several investment properties (or even one) and have been able to build up a significant amount of equity then it might be time to take some cash off the table and crystallise some gains.
Of course you would have to look at this in conjunction with your financial and lifestyle goals as a family as well as your tax position with your accountant or financial advisor to ensure it was a sensible move from a numbers point of view. You’d then have to consider what you would do with those funds – and that might be more headache than you’re prepared to take on right now.
The call is yours.
If you’re looking for help with working out your family’s finances get in touch to see how I can help.
Remember – You’ve got to own your finances if you want a financially secure future.