How an Early Rise in Interest Rates Could Affect Your Home Loan

It looks like the RBA may increase interest rates sooner than expected – and this could impact your monthly repayments.

The Australian housing market has been exceeding expectations during this pandemic, with over 200 suburbs joining the million-dollar club in the past 12 months and the total value of residential dwellings in Australia rising to a record-high $8.29b. 

Much of this growth has been spurred on by the Reserve Bank of Australia’s (RBA) record-low cash rate of 0.1% during the pandemic, and their declaration to keep rates this low until 2024. This has encouraged many Australians to get into the property market, or to purchase additional property, as many found themselves with additional savings due to the inability to travel overseas and wanted to capitalise on substantially reduced home loans. 

Comparatively, the 2015 cash rate set by the RBA was at 2.25%, which is more than twenty times higher than the current rate. 

However, the record-low home loan interest rates that Australians have been enjoying might come to an end sooner than expected, according to economists at the Commonwealth Bank of Australia (CBA). 

According to the CBA’s head of Australian economics, Gareth Aird, the RBA could lift interest rates to 1.25% by September 2023, with incremental increases occurring throughout 2022-23. 

“Our central scenario has the RBA delivering the first hike in the cash rate in November 2022,” said Aird, who went on to say that CBA has “pencilled in an increase of 15 basis points, which would take the cash rate to 0.25 per cent.”

“We expect that to be followed by an increase of 25 basis points in December 2022. We have three further 25-basis-point hikes in Q1 23, Q2 23 and Q3 23.”

The belief that the cash rate will rise before 2024 has also been shared by other big banks like ANZ and Westpac which predict that rates will rise in 2023. 

“There are scenarios that could see the RBA pull the rate-hike trigger earlier than November 2022, particularly if they tweak their reaction function because it becomes irrefutable that wages growth is on a path to 3 per cent per annum (the rate of growth they have targeted),” said Aird. 

“Alternatively, the RBA could delay hiking the cash rate if growth in labour supply was to accelerate quickly when the international border is reopened.”

How will a rise in the cash rate impact home loans? 

The RBA’s cash rate determines how much the other banks have to pay in interest on their loans, and as such, banks like CBA, Westpac and ANZ pass on those cash rate increases to borrowers.

Borrowers can choose between having a fixed rate or a variable rate on their loans, meaning that either the interest rate that they pay on their loan will fluctuate alongside changes in their bank’s interest rate (this is a variable interest rate), or their interest rates will remain locked in over a period of 1-5 years (this is a fixed interest rate).

Historically, most people have opted for variable rates on their loans, as variable rates have typically been lower than fixed rates. However, fixed rates are currently lower than variable rates, which has prompted roughly 50% of Australians to go for a fixed interest rate on their home loan compared with the roughly 15% that have opted for fixed rates in the past. 

If you are one of the Australians that has a fixed interest rate on their home loan, an early rise of the RBA’s cash rate won’t impact the monthly repayments you’ll have to make. 

However, if your home loan repayments have a variable interest rate, you will be affected by an increase in the RBA’s cash rate.

If the RBA does increase rates to 1.25% by September 2023, those on a variable interest rate will incur that increase on their mortgage repayments. To use an example given by the ABC: “a 1.15-percentage-point rise in the cash rate would take the typical owner-occupier mortgage rate from 3.10 to 4.25 per cent and the average investor rate from 3.44 to 4.59 per cent. On a $500,000 mortgage, that rate increase would result in a $324 per month increase in repayments.”

Given that the average mortgage in Australia for owner-occupiers was $481,790 in January if the CBA’s predictions are right, most Australians with a roughly half-million-dollar home loan on a variable interest rate will be looking at an additional $300+ in their monthly repayments by 2023. 

As such, you will want to ensure you’re prepared for the potential interest rate hikes that may come in 2022-2023 and get your budget ready for an increase in your monthly repayments.