How to plan for interest rate rises

By Daniel Senia

Knowing when to expect interest rate rises in Australia and how to prepare your budget accordingly will mean that you are better equipped to manage financially if you’re hit with rising interest rates.

Why did interest rates rise in 2022?

In May, the Reserve Bank raised the cash interest rate, for the first time in 11 years. Since then, the interest rate has risen at every Reserve Bank of Australia monthly meeting.

Economists agree that increasing the cash rate is the right way to tackle rising inflation.

During the pandemic the economy slowed down due to large parts of the country being in lockdown.

So the Reserve Bank kept interest rates at record lows of 0.1 per cent.

Now the pandemic restrictions are easing, and the economy is bouncing back, which has caused inflation. To cool rising prices, the Reserve Bank increases interest rates to curtail demand.

 

How interest rates affect borrowing

If you are looking to get into the housing market, you’ll no doubt be concerned about interest rates.

A rising interest rate means you will likely pay a little more each month in repayments once you purchase or build your new home, and it will also affect the amount the bank will lend you in the first place.

What is important to remember is that the unprecedented low interest rates we’ve seen through COVID is an anomaly.

It would be irresponsible to think that these sorts of rates could be supported forever.

A healthy economy with an inflation rate of 2-3 per cent (which is the Reserve Bank’s aim in their fiscal policy) normally sees interest rates somewhere between 2 per cent and 5 per cent, meaning we are entering a more normalised market.

 

How far will interest rates rise in Australia?

We aren’t precisely sure how far rates will officially rise.

However, most banks and economists agree that rate rises are expected until the inflation rate slows, to a cash rate of about 3.5-4 per cent.

This is expected to peak in early-mid 2023.

While there is a lot of fear-mongering in the media, the goal of the RBA is not to bankrupt households, but to slow inflation, which is already beginning to happen.

Remember, while interest rates are rising, the goal is to stop the rising costs of goods and services we are all consuming every day, which is also a factor in your overall budget.

 

How to prepare for rising interest rates

It’s important to be prepared to manage your budget so you can still afford repayments.

• Step one: evaluate your budget

Review your spending including any current and future mortgage payments. Do you have any money left over once your mortgage payments and cost of living expenses are allocated?

Run simple scenarios of different interest rate rises, for example, if your existing interest rates are 2 per cent, calculate your repayments if rates were at 3 per cent and 4 per cent.

Rates may not rise to these levels, but it will give you a good idea of what you can afford.

• Step two: consider potential cost reductions

Are there any unnecessary expenses that you can cut that will allow you to cover additional mortgage repayments?

Perhaps you can reduce your living costs that will give you more savings as a buffer.

Expenses like travel and entertainment can typically be reduced.

• Step three: speak to a mortgage expert

Mortgage brokers can help you prepare for an interest rate rise by helping you shop around for a home loan that gives you a better deal.

Brokers also negotiate with banks on your behalf.

Daniel Senia is the managing director of First-Place Building Co. with more than 18 years’ experience in the new home buying industry working with some of Australia’s largest home builders and developers.