Interest rates are on the rise. NZ, Canada, the UK, and the United States, have all started bringing rates back to more normal levels. Our Reserve Bank followed suit, lifting rates in May 2022.
For those with debt, we’ve all enjoyed the incredibly low interest rates of the past few years. But all good things must come to an end. And for those with savings, they are quite likely looking forward to getting more reasonable returns on their money.
Now for most people, rising interest rates, provided the rise isn’t too great, will have no impact on their cash flows. This is because the overwhelming majority of people with mortgages pay more than the minimum loan repayment. If you’ve had your loan for more than three or four years then likely your repayments were set when rates were considerably higher than they are today. If you have continued to make your repayments at the same rate as you did originally, then you will now be nicely ahead on your mortgage and when rates get back to more normal levels, your repayments will still align with getting your loan cleared within the contracted term.
But what if that is not the situation you face? Perhaps you’ve got your loan more recently and the repayments you’re making reflect current interest rates. Or maybe you adjusted down your repayments as rates dropped to free up cash for other purposes. Let’s take a look at a few options that you have to get yourself ahead of rising interest rates.
The first obvious thing to do is increase your monthly repayments. If you wanted, you could do some estimates of what your loan repayment will become at higher interest rates using the Moneysmart Mortgage Calculator tool. The challenge is we don’t know how high rates will go and how rapidly. But whatever you can afford to chip in extra will clearly help cushion the blow if rates rise. If you start now you will get a little ahead on your loan, which means that when the rates do rise the adjustment in your repayments that is required will be a little less.
You could look at fixing the interest rate on your loan. Fixed loans have their challenges, mainly around reducing your flexibility. However if you’re concerned about your loan repayments becoming unaffordable in the event of several rate rises, then you might look upon fixing your rate as a form of insurance. Of course the banks know that rates are rising, so fixed rates have already adjusted up. But nevertheless it is something that you might wish to explore. I have covered this before in a past podcast episode but I would encourage you not to use fixed rates is a way to speculate on the interest rate market. Hundreds of thousands of professional market participants with much better information then you have are trading in this space every minute. The chances of you correctly picking that the current fixed rates on offer are missed priced, is little different to you playing blackjack at the casino. You might win, but the odds are stacked against you. This is why I mentioned earlier that you should instead think about fixing your rates as a form of insurance where you determine that a rise in rates is going to cause you significant pain and potentially mean you are unable to retain your property.
You could also ask the bank to lengthen the term of your loan. Let’s say you took out a loan five years ago and the term was 25 years. Today that would mean you have 20 years left to pay that loan off. If rising interest rates will mean that your regular repayments will become unaffordable, you could speak to your bank about rejigging your loan so you have longer to pay it off, perhaps 25 or 30 years rather than the 20 that you now face. By stretching out the loan term your monthly repayments will reduce. Now there’s no such thing as a free lunch here. Making this change will ultimately mean you pay more interest over the life of your loan. But if it’s what you need to do to get the cash flow to work then it’s certainly an option worth exploring.
You may be able to shop around for a better deal on your loan. Changing loans is no small undertaking, so before making any changes ensure that the benefit you will gain is meaningful. But there’s no harm in doing a little Internet research and seeing whether the deal you’ve got is as competitive as you would hope. Sometimes having done this research, you can go back to your current bank, make them aware that you found cheaper rates elsewhere, and you may find that they match the offer or at least improve the deal that you are on.
If you are like most people and have been paying more than the minimum off your home loan, then you will have funds available in redraw, or depending on how you’ve structured things they could be in an offset account. This gives you a fantastic buffer that protects you quite significantly from rising interest rates, but of course that doesn’t work if you draw the funds out to go on holidays, buy a car, or spend it in some other way. So if these last few years of low interest rates has allowed you to get ahead on your loan, don’t squander that. That buffer will enable you to continue with the repayments that you’ve always paid, ensuring a rising interest rate environment does not cause you financial stress.
Thus far I’ve been thinking mainly about homeowners, but this topic also relates to investment property owners as well. If you own an investment property you’re likely to be sensitive to the difference between how much rent your property brings in and how much you need to pay out in loan repayments. Check your numbers, and if it is the case that as higher interest rates roll through, the rent coming in is no longer adequate to make the whole proposition attractive, talk to your managing agent about whether there is scope to raise the rent you are charging. It can be tempting if you have a reliable tenant to not want to upset the applecart, and simply leave the rent at the same rate for several years on end. This is a lovely thing to do, and if it means keeping a good tenant, it may well make sense, but in a world of rising interest rates, likely you will need to raise the rent you charge to ensure your investment remains profitable.
A final point before I sign off. None of us knows how high interest rates will go or how quickly they will rise. Most forecasts I’m seeing are showing rates getting to the high 3-4% range, but who is to know? No one would have forecast interest rates starting with a 2 four or five years back. So be cautious with new borrowings that you undertake, ensure you leave yourself a comfortable buffer, hold the applicable insurances to give you comfort, and be sure to run your numbers based on higher rates than they are today if considering a new loan.
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