Interest rates are up – which is quite the down-er for mortgage holders.
On the average $694,000 loan, the rate rise equates to more than an extra $100 a month… so $1200-plus a year.
Or does it?
If you are in the wrong mortgage, switching to the right one could – in fact – snare you the equivalent of four rate cuts… today.
So, let’s check with the five questions that determine it.
Question 1: Is your rate competitive?
Pretty much all lenders will move in lockstep with the RBA, and quite quickly, to lift rates by the same as the official 25 basis points.
But if you have been paying too much in the first place, it’s possible you could escape that hip-pocket hit. Indeed, it’s possible you could swap it for a saving.
Let’s first establish your interest rate benchmark though, before we get into if you could do better.
The average variable rate looks like coming in at roughly 6.4 percent, post rate rise. However, there are quality loans out there that are still charging way down near 5.45 percent.
What kind of saving might you be talking? If you hold that average $694,000 mortgage, you will save $286 a month from the $4527 you have been paying if you secure that lower level rate… both avoiding the latest hike and instead giving yourself three ‘cuts’.
But is fixed or variable best?
Question 2: Should it be fixed or variable?
The thing to realise about fixed rates is that they are priced for lenders to profit. That’s true at any point in an interest rate cycle but it’s particularly likely when official interest rates are about to rise or indeed already rising: fixed rates always go up first.
Sadly, it’s usually subsequently that most borrowers realise the prospect of paying more on a variable rate is very real and start thinking about locking in. That’s when you end up paying too much.
Plus, the decision to commit to a fix is a tricky one, thus I have two golden rules:
Only ever fix half your mortgage… interest rate expectations can turn on the head of a pin and this way you are making a two-way bet and won’t ever be stuck paying over the odds on your whole mortgage.
Only ever fix for a maximum of three years… this is for the same reason as above – you will want a commitment that ended up being wrong to end soon-ish.
The other loan-type question involves repayments.
Question 3: Is your loan on the right basis?
There are two ways to repay a loan – principal and interest, and interest-only.
Interest-only repayments, without any principal component, are cheaper.
But do you want that?
Principal and interest repayments are the safest and surest way to own a property – with them, you are month by month building your equity in the property.
For this reason, they are highly recommended for your home. Indeed, a lender may well not extend you a loan on an interest-only basis.
Sometimes interest-only loans, though, are on offer for investment properties.
But why wouldn’t you seek to repay these – so ultimately own them outright – too?
Because a higher loan balance means higher tax breaks.
Even with investment properties, however, it’s a decision to weigh carefully.
There’s one loan feature that is a no-brainer though.
Question 4: Do you have an offset account?
This magic little Australian invention is really a debt-busting secret weapon. Let me break it down.
An offset account is a savings account that is hooked to and runs in parallel with your mortgage.
Every dollar you hold in it is offset against your loan balance. So, if you have a $100,000 home loan and $10,000 in an offset, you only pay interest on $90,000.
The interest saving will always be larger than what you can earn in a separate savings account. What’s more, from money you earn, you will lose tax.
An offset is far more advantageous… and will also cut your time in debt for ‘free’.
Consider holding any savings you have to your name in offset accounts – you can usually have multiple offset accounts, separately labelled for the money’s purpose.
So, if you think you’re in the wrong loan, can you do anything about it?
Question 5: Are you in a good spot to refinance and save?
Unless you are in a fixed-rate loan – for which you are contracted for the term you agreed up-front – you should be able to refinance to a better and/or more appropriate loan.
And here’s another angle: The more equity you hold, the lower the interest rate you might be able to get.
Many lenders offer tiered rates that are reduced for people who have less debt against their property.
Bottom line:
Far from feeling at the mercy of the RBA, you might be able to secure a far cheaper rate and an instant saving from a mortgage ‘ditch and switch’.
Particularly if you in the wrong loan, the right one could save you significantly.
