Let’s be real here. Interest rate hikes are inevitable.
At the time of writing, interest rates are at all-time lows. In Australia, the RBA cash rate is currently at 1.5%. While that’s not the rate that banks charge – the lowest according to Mortgage Choice at time of writing was 3.96% although some smaller lenders like UBank may offer even better rates for a maximum of 80% lend.
What this has meant is that a lot of people have gotten into a rather large amount of debt. I won’t bullshit you, me included. We went a little overboard, listened to the emotional rather than irrational side of my brain, and went well and beyond the budget. Now we are paying for it.
You do not want to be like us.
Interest rates are low now, the talk is that they will remain at these levels for at least another 12 months. That’s good news. But what happens when they start going up.
A 1% rate difference on a loan of $300,000 at 4% is $1432.25, if it goes up to 5% that’s $1610.46. Less than $200. But what if your loan is for $700,000? Then you’re paying $3341.90 at 4% but if it goes up by just 1% the repayments are $3757.76 or a $415.86.
Could you handle an extra $400 in interest repayments?
I know I wouldn’t want to.
But there are ways that you can protect yourself from rate hikes.
While you have little control over what the RBA or the Fed does to interest rates and how lenders react, you can control three things.
1. Your repayments
2. The structure of your loan
3. Avoiding debt
MAKE EXTRA REPAYMENTS FROM DAY ONE
Regardless of your interest rate, extra repayments should be at the top of the list if you have any sort of loan. The longer the loan term the more interest you are going to pay.
By making extra repayments you are going to pay off your loan sooner, well duh. But the other benefit is that you’re going to create a buffer should interest rates increase to unmanageable levels. Yes, this can happen. In the 1990s, mortgage interest rates were hovering around the 17%. Sure you could purchase a decent house for $100,000 but the average weekly wage was under $550 per week.
Consider extra repayments as an alternative to putting cash in your savings account. It’s unlikely that the earnings on your savings account are going to exceed the amount of interest you are paying on your loan so it’s better to have a redraw option and throw all your money into your loan account.
FIX PART OF YOUR LOAN
Fixing part of your loan for a limited period of time will ensure that you are protected against rate hikes at least in the short-term. The downside is that you also risk paying a higher rate in the short-term should interest rates drop. That’s just the risk that you have to take.
You can fix your mortgage for 1 – 5 years. It’s probably dangerous to do it for any longer than that. If interest rates are at super low levels, go for the longest period possible at the best available rate.
Keep in mind, you do not have to fix 100% of your loan. If you’re planning on making extra repayments then it’s best to probably keep 20% of your loan at variable rates. The reason for this is that lenders can charge you fees if you make too many extra repayments on the fixed portion of your loan.
Check with your lender, each one has their own rules and regulations, but most will have a limit on how much extra repayments you can make on a fixed mortgage rate.
PAY FOR EVERYTHING IN CASH
Sounds easier said than done but the truth is the best protection against interest rate hikes is to avoid any sort of loans or credit at all costs.
Cash is king and if you’re a capable saver than it’s best that you stash away as much money as possible and pay for everything in cash.
Yes, it’s possible to pay for the majority of your home in cash. It might take you an extra few years to save but that’s nothing to what you’ll be saving by avoiding going through the hellish process of getting a mortgage and paying the lender a shit load in interest.
How do you buy a home for cash? Start saving right now.
Couples on decent incomes will be in the best position to do this, but it’s possible for anyone to save, it all depends on what they are willing to sacrifice to reach their goals.
Let’s say you have a couple, Jack and Jill, they both earn $4,000 per month and can each save $1500 per month after they’ve paid the rent and covered all expenses. After 1 year, they have $34,000. Five years later, their balance is about $170,000.
While you can’t buy a house for that amount of money where I live, you might be able to pick up a studio apartment. But what if you’re happy renting. What do you do with $170,000? You can invest in shares and earn income through dividends. You can buy one or two investment properties and have the tenants pay them off via the rent. Or you can use the cash as a nice deposit for your own home. Or just keep stashing the cash away if that makes you happy.