How clients can ease pain of latest rise
The official cash rate has hit 1.35%, increasing by 50 basis points from 0.85%, the Reserve Bank of Australia has announced.
The interest rate on exchange settlement balances has also increased by 50 basis points, to 1.25 percent.
It marks the third successive rise this year, after the RBA took the cash rate off a record-low 10 basis points, hiking it by 25 basis points in May. This was followed by a 50 basis point hike in June - a total hike of 1.25% this year.
Delivering the July monetary policy statement, RBA governor Philip Lowe said inflation continued to track at a level beyond the central bank’s 2-3% annual target over the medium term.
“Global inflation is high. It is being boosted by COVID-related disruptions to supply chains, the war in Ukraine and strong demand which is putting pressure on productive capacity. Monetary policy globally is responding to this higher inflation, although it will be some time yet before inflation returns to target in most countries,” Lowe said.
Annual inflation remained at 5.1% (ABS March 2022). Inflation in Australia was also high, but not as high as other countries, he said. Domestic factors, such as the tight labour market and capacity constraints in some sectors, put an upward pressure on prices.
Lowe said inflation would peak later this year, before declining back towards the 2-3 percent range next year. The Australian economy remained resilient, and the labour market was tighter than it had been for some time. Underemployment had fallen significantly, he said.
Although recent household spending data was positive, the Board noted that household budgets were under pressure from higher prices and higher interest rates.
Read more: Single or double shot rise for the official cash rate?
More than Mortgages founder and principal mortgage broker Deanna Ezzy (pictured above left) said the July cash rate hike wasn’t a surprise. Fixed home loan rates started to edge higher in October 2021, she said.
When talking to clients with existing mortgages as well as prospective borrowers, Ezzy said her main advice was not to panic.
Whilst interest rates remained at historical lows, she said it was also important that borrowers don’t bury their head in the sand. Preparing and budgeting for rate rises early would avoid mortgage stress in the future.
Based on the assumption that a client’s home loan interest rate would rise by two percentage points in the next couple of years, Ezzy suggested they get used to paying the higher monthly repayment now. The extra money could be put into an offset account, redraw facility or special savings account.
“As rates go up, they won’t notice it, because they’re already paying a higher amount. While the variable rate is still low, they’ll be paying the loan off quicker and building redraw into the loan,” Ezzy said.
When speaking to a new client, Ezzy said she showed them what their repayments would be now (based on current rates), and at a rate of 5.5%.
“I also factor in 1% of the property value per annum (e.g. $7,500 for a property valued at $750,000), to account for expenses like council rates, body corporate fees, house insurance, repairs/maintenance, etc,” Ezzy said.
If clients were unable to afford the repayment at 5.5% (plus the additional 1% in property-related expenses), Ezzy said she would generally advise a client to reduce the price range of properties they were looking at.
“I’m also suggesting that clients leave more of a cash buffer in case rates do rise quickly, and more than expected, so they have cash savings to help supplement the higher repayments,” Ezzy said.
Asked about current trends around fixed and variable home loan rates, Ezzy said certain clients were reluctant to break existing lower fixed rate loans, such as to finance major home renovations. This was in the view that they would need to break their lower fixed rate, therefore increasing their repayments, and due to a reluctance to change lenders if they don’t meet servicing requirements.
Read more: Could inflation tip the economy into stagflation?
Referring to the official cash rate of 1.50% in 2019, Hills Finance director and principal Leigh Paliwal (pictured above right), said Tuesday’s hike amounted to a further normalising of interest rates after a period of all-time lows.
Over the last couple of years, lenders have stress-tested borrowers at higher interest rate levels. For example, servicing assessment buffers of 3% plus have applied on top of the rate provided to a client, Paliwal said. There’s also been increased focus on verification of living expenses.
For existing borrowers, these precautions indicate that the impact of rate rises should not be significant, she said. Rate rises were likely to reduce borrowing capacity for new borrowers, meaning brokers played a key role in helping them find solutions to suit their needs.
“We are providing regular communications to our client database, whether it is over the phone or via email, as RBA announcements are released to keep them informed on what this means and how that impacts them,” Paliwal said.
Assuming lenders pass on the full percentage point increase to variable rates in July, Paliwal still expected variable rates to remain popular with borrowers, as they remained lower than fixed rates and could be used as a benchmark for estimating future repayments.
“We only need to apply the cash rate increases to whatever the variable rate is at the time to understand what an increased rate or repayment may be,” Paliwal said.
Following the RBA’s 75-basis point increase to the cash rate target over May and June, July insights released by financial comparison website Mozo showed 71 lenders passed on the rate hike in full.
If lenders were to pass on the full 50 basis point July hike, Mozo’s calculations show the average variable rate would jump to 4.15%, and the average big four bank rate would top 4.70%. For borrowers paying principal and interest, based on an average $400,000 variable home loan over a 25-year term, borrowers would need to find an extra $1,320 per year.
Just under half (45%) of respondents Mozo surveyed said a home loan interest rate over 4% would put them under serious financial stress.
Mozo spokesperson Tom Godfrey (pictured above centre), said it was important for home loan customers to compare rates and seek out a better deal.
“With interest rates continuing to climb, its clear many home loan customers are under increasing financial stress. Significantly higher interest rates, coupled with bigger average loan sizes and wider cost-of-living pressures, is a recipe for disaster for household budgets,” Godfrey said.
