In this article, Velocity Finance Director Brendon Ojala discusses the impact of rising interest rates on lending and offers advice to anyone looking to borrow or refinance.
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You would have needed to be wandering in the bush or sailing the world (we wish!) over the last few months not to be aware that interest rates are on their way up again.
Interest rates rose by 1% in four months
That is a significant rise over a brief period and has led to lots of questions and discussions with our clients over the last few months.
The question on everyone's minds is: "What is the best interest rate strategy for my Home Loan?" Let’s dive in to that a bit more.
In our day-to-day business at Velocity, we have been seeing different approaches to rising interest rates for our borrowers, including longer fixed periods and split loans, as borrowers seek more certainty.
Fixed home loans over longer periods
Up until mid-year, many of our clients took the lowest rate available. In recent months, as rates have risen, we have seen our clients opting to fix their Home Loans for longer periods of two-five years, choosing to pay more overall, in exchange for greater certainty. Other clients have been breaking their current fixed loans, choosing to fix them at higher rates to achieve longer term certainty.
We have seen our clients opting to fix their Home Loans for longer periods of two-five years, choosing to pay more overall, in exchange for greater certainty.
Fixed loans divided and split over different periods
We are also seeing clients choosing to“ hedge their bets" by splitting their fixed loans between different lengths.
Here is what ANZ said this month in their October 2021 Interest Rate commentary:
Mortgage rates continue to rise rapidly, with average fixed rates up between 0.41% pts and 0.57% pts over the past month. There were two main catalysts for the increases. The first was the Reserve Bank of New Zealand’s decision to hike earlier this month. Not only was that the first Official Cash Rate (OCR) hike in seven years; the Reserve Bank of New Zealand also warned that further hikes will follow. This was further reinforced by the release of Q2 inflation data, which was much higher than expected, fuelling financial market fears that the OCR may have to rise a lot further. Consequently, term wholesale rates have moved up sharply, which has in turn driven mortgage rates higher. All rates are now above 3% (on average).
The 1-year rate remains the lowest; it’s also the one we now prefer. It doesn’t offer much time protection, but it’s a lot cheaper than floating. We believe the prime opportunity to fix has now passed, with longer-term rates now much higher and significantly less attractive than they once were.
ANZ, October 2021: The Tide is Turning
I find ANZ’s commentary interesting. ANZ are suggesting that there was a time when it made sense to lock in for a longer period, however now that those longer rates have risen, it is best to keep fixing loans for shorten time periods (which ironically, is what most people had been doing anyway.)
With interest rates on the rise, I suggest the following to keep in mind when managing your home loan.
Expect interest rates to continue rising
We base this view on indications from the Reserve Bank and inflation forecasts. It is difficult to predict how fast, and how far, they will rise, but we can be certain that rates will keep rising.
Get strategic, not reactive
It is easy to read a headline on changing interest rates and make reactive decisions. Devising a clever, longer-term strategy with appropriate adjustments over time, makes sense. Interest rates will go up, yes, but they will go down again. Managing your home loan is a long-term game, so I would encourage you to think longer term and get strategic in your approach, as opposed to reactive.
Keeping in mind your strategic approach to your home loan, avoid procrastination when your fixed rates come due. Make a timely decision and act on it, when your fixed rates come due (best between 45-60 days beforehand, bank-dependent). In a world of rising interest rates, the rates offered by the banks will only last for a few days, at best. If you don't commit before they 'expire,' there are no guarantees that the same rates will be available.
In a world of rising interest rates, the rates offered by the banks will only last for a few days, at best
Work and understand your figures
Do you know what impact higher interest rates have on your actual repayments and your household budget? Work through your numbers to understand your position clearly. For some, a rise in interest rates may not be material to your overall financial position. If this is the case, then it is very much business as usual for you. However, if a rates increase is material to your position, then this becomes a significant decision, and requires a more in-depth conversation around your loan strategy and options.
If you have extra funds, use them
If you have a budget surplus, or the ability to earn extra income, use it to pay down your debt. Even small amounts can have big impacts on the length of your loan, as well as the amount of interest you pay the bank.
When it comes to setting up your home loan strategy, you have a few options. Below are three fixed rate strategies for the majority of your loan, and the pros and cons of each.
That is, make the whole of your fixed rate portion of your home loan over three to five years. While you may be paying more, you could be better off over the long run, if rates continue to rise significantly. (As above, the ANZ economists may not agree with this)
Repayments will be as cheap as possible now, and over the average longer term you may still win. However, you run the risk of incurring higher rates later when the short period expires.
Hedge your risk
Split your loan into different suffixes, with different fixed terms. It won't be the cheapest option for now, but regardless of what happens to rates, it will have less impact on your overall Home Loan payments, than would be the case over a variety of scenarios.
Talk to your adviser
It is impossible to predict what interest rates will do, and every decision made around loans will carry some uncertainty and risk. Your adviser will help you work through the options and make an informed decisions that best suits your personal situation.
Hi, I'm Brendon, one of the Directors and Advisers at Velocity Financial. I have been giving advice on mortgages and insurances at Velocity for over 15 years, and it is great to be able to work with people to achieve their financial goals. Prior to giving money advice, I worked as a youth worker and managed teams for a not-for-profit organisation. I live with my wife and one of my sons (the other one only stays when he needs food) in Berhampore, and if I'm not talking revolving credit accounts, I can be found running the trails of Wellington.
Disclaimer: Brendon Ojala (FSP119244) is a Financial Adviser with Velocity Financial (FSP95466). No investment decision should be taken based on the information in this blog alone. Please see Brendon’s disclosure statement on our website.