Beating end-of-term blues

Millions of Australians on low fixed-rate loans will be bracing for impact when they expire in the next year.

It’s time to get prepared to manage the bill shock of coming off a fixed rate.

Don’t panic but start planning

Until recently, many Australian mortgage holders have only ever experienced interest rates heading in one direction: down. No wonder it was a culture shock when the Reserve Bank began ratcheting up the cash rates for the first time in more than a decade this year.

And it looks like the only way is up. Economists predict the official cash rate will have jumped about 1.75 per cent by the end of the year.

Buyers who locked in fixed rates when they hit rock bottom in mid-2021 are sitting pretty, for now. But when their fixed-terms expire, they’ll face an overnight leap, rather than a gradual increase. Interest rates locked in for two years at 2.2 per cent in 2021 could revert to above 5 per cent in 2023. It can be a rude awakening.

But there’s no need to panic. If you’ve fixed wisely, you’ve already made savings. Look at an approaching expiry date not as a cliff but as an opportunity to track down the next great deal.

It’s never too early to start weighing up options. This is where a long-term relationship with a broker can pay off to run the numbers, stay across the market and talk through scenarios.

Refinance, re-fix or split?

When the term of a fixed-rate loan ends, borrowers move on to what’s known as a ‘revert rate’ of interest.

The bad news is that this variable rate is often higher than others offered by the same lender. The good news is you don’t have to stick with it.

Because the fixed-term has ended, borrowers are free to shop around without incurring a penalty. The options are wide open: a lower variable rate with the same lender or a competitor; another fixed rate, or a split loan with part fixed and part variable. These days loans can even be structured as split fixed loans, with part fixed for two years, and the remainder for five, for example.

Overseas, where inflation has hit much harder, some borrowers are jumping early and paying exit fees to end fixed-term loans so they can lock in new fixed mortgages. In the UK, Yorkshire Building Society has reported a spike of more than 88 per cent in the number of consumers paying these break fees to refinance.

This can stack up if borrowers expect rates to rise significantly in coming years.

As of July, average variable rates were around 3.85 per cent while two-year fixed rates were closer to 4.8 per cent, according to financial comparison site Mozo.

Australia has also seen a rush to refinance according to ABS data released in July, which shows a 20 per cent jump in owner-occupiers negotiating mortgages.

Practice makes perfect

Borrowers concerned about reverting to a higher rate of interest can run a stress test on their budgets by calculating approximately what repayments will jump to when the fixed-term ends, then start paying it.

Be aware, fixed-term loans have repayment ceilings you can’t exceed without incurring penalties, so check this carefully. If you are unable to pay extra into your loan, put additional payments into a savings account that can be used to pay down the loan principal when you revert to a variable rate.

Going with more flexibility

With interest rates rising, borrowers may want to go with a variable rate to access more flexible options to pay down principal.

• Pay fortnightly: It’s a classic tip, but one not many put into practise. Switching to this payment method can help absorb increased repayments. Making two fortnightly payments instead of one monthly payment has a small impact on your day-to-day budgeting, but a big impact over years. If you pay in two fortnights what you would normally pay each month, you will end up knocking off an extra month of repayments each year. Over the lifetime of an average 30-year loan, this can stack up to more than $100,000 in interest savings.
• Use an offset account: An offset account is a transaction account linked to a variable rate home loan. Interest is calculated only on the loan balance minus the balance of the offset account. Keeping cash in this account helps keep interest payments down without locking your money away.

Beware the mortgage prison

Some borrowers may find their refinancing options restricted by tighter lending requirements and falling equity, as housing markets come off the boil.

From November last year, banking regulator Australian Prudential Regulation Authority (APRA) has required banks to use a 3 per cent buffer to assess whether borrowers can service loans. Previously this was 2.5 per cent. Those who borrowed under the previous regulations and have not paid down principal may find it difficult to meet the higher serviceability bar to refinance.

Similarly, falling equity in areas where prices have dropped may leave some in a situation where the loan to value ratio goes above 80 per cent and Lender’s Mortgage Insurance is required to refinance. Their only option may be to negotiate with their current lender.

Your personal circumstances are unique and approaching a fixed-term expiry is a key time to get in touch so we can reassess. It’s a rapidly changing environment and I’m happy to meet to discuss the most up-to-date options so you can plan ahead to make the best decision.

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