How does an Official Cash Rate change affect you?

How does an Official Cash Rate change affect you?

With home loan interest rates at tantalisingly low levels, loan applications are soaring and property buyers are excited by the prospect of getting more for their money and paying off their home loan sooner. When the RBA reduced the Official Cash Rate (OCR), most lenders passed on the 0.25 percent to borrowers in the form of a 25 basis-point cut in their home loan interest rate.

What this means is borrowers save money on interest, so technically their repayments are lower. Ideally, they would keep their actual repayments at the same amount so their loan is paid off sooner to save even more on their interest bill. This is because the interest saved is now going towards the home loan balance, so it is paid off sooner. However, new borrowers will go into their loan at a very low interest rate and they will be accustomed to their repayments being comparatively low. 

People with long memories know standard variable home loan interest rates have traditionally been a lot higher than they are now. In 1990, interest rates were around 17 percent. In 2000 they were hovering around 8 percent, and in 2010 closed around the same level.  Now they are close to 4 percent. While it’s great news that borrowers are currently paying lower rates of interest on their home loans, it’s not set in stone that interest rates will stay low for the term of their home loan.
Responsible lenders won’t let their customers borrow more than they can afford, or get themselves into a situation where they can’t meet their repayments if interest rates rise. They factor this into their lending criteria and calculations. So, even though interest rates are low, it doesn’t mean finance is easier to get or that lenders have relaxed their policies on what it takes to qualify for a loan.

Realistically, this means there shouldn’t be a large group of borrowers who have come into the property market with a loan they can afford now but would struggle to maintain if interest rates increased. However, borrowers who have entered the market when interest rates are very low may still find themselves needing to tighten their belts when faced with a rate rise because they have never experienced what it means to make home loan repayments at a high interest rate. A rise of just 1 percent can mean an extra $205 a month on a loan of $300,000.

There is no need to feel powerless, though, because there are ways to give yourself a buffer against the bite of interest rate rises. Firstly, pay principal and interest rather than interest only. Choose a flexible loan that allows you to make extra repayments and get as far ahead as you can while interest rates are low. That will help to reduce the loan principal so interest rate rises have less of an impact. It will also get you accustomed to paying at a higher rate so if interest rates rise, you won’t feel it as keenly. And, third, choose a loan that has a mortgage offset facility and keep your savings in there to reduce the interest you pay.

Plan ahead to make sure an interest rate rise isn’t a pain in the hip pocket.

Image credit: Pallspera