Rising home loan interest rates explained

We believe the best way to help customers protect their wealthy is through the power of educating and staying informed.

What your customers need to know

When it comes to paying off our home loans, we’ve never had it so good.

The economic impact of COVID-19 has been keeping a lid on interest rates in recent years. But they were on a downward trajectory even before the pandemic, with the last increase coming in late 2010. In fact, interest rates have been so low for so long that a generation of Australian home buyers has grown up with no experience of rising rates.

But sadly, all good things must come to an end. Interest rates have begun to rise following the Reserve Bank of Australia’s decision to increase the cash rate for the first time in over a decade. And with high household debt levels, it could make life difficult for millions of Australians as regular mortgage repayments start to increase.

But the good news is there are ways your customers can structure their home loan and adjust their spending to help with rising repayments as the new rate landscape takes shape.

What's the official cash rate?

The official cash rate sets the interest rate for overnight transactions between banks. It’s a tool used by the RBA to influence economic activity and manage inflation. An increase in the official cash rate generally means an increase in the cost of borrowing money. So when the RBA changes the official cash rate, the banks tend to follow suit and change their lending rates.

How do banks set interest rates?

The official cash rate isn’t the only factor that influences bank lending rates, but it’s one of the most important. To make money, banks need to lend money out at a higher rate than they borrow – this is why the interest rate your customers receive on their savings account tends to be lower than the interest rate they pay on their home loan. So an increase in the cost of borrowing money can affect your customers in different ways, depending on whether they’re a saver or a borrower. If they have a savings account or they’re thinking of taking out a term deposit, they could start to receive more interest on the money they’ve lent to the bank. But if they have a home loan they could start to pay more interest on the money they’ve borrowed from the bank.

Why are interest rates rising?

The RBA is looking to control inflation in a bid to stabilise the Australian economy, which is seeing higher prices, lower unemployment and signs of potential wage growth. Check out AMP Chief Economist Shane Oliver’s recent article about the background to rate rises and what we can expect over the next 18 months.

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What can your customers do to reduce rising rates impacts?

1. Tailor their home loan to suit

The way your customers structure their home loan could help them pay less interest in the long run and take years off their mortgage. As we see rates start to increase, it’s a good idea to think carefully about what type of loan best suits their needs – fixed, variable, or split. It’s a big decision and could have a significant impact on their future repayments and household budgeting as rates rise.

Fixed rate loans

A fixed rate loan has a set rate even if interest rates rise.

They can lock in the interest rate for a period of time – generally one to five years – depending on factors such as the total amount borrowed and the overall loan term.
They can choose to fix their rate again at the end of the fixed-rate term, or let it roll to a variable rate.

A fixed rate home loan could not only give your customer the certainty in repayments, it could also help them manage their household budget more easily. But there usually isn’t the flexibility to make extra repayments so they can’t pay off the loan by making additional repayments. And they might also be up for break costs if they want to make any changes such as exiting the loan before it ends.

Variable rate loans

The interest rate your customers pay over the life of your loan can change as banks vary their lending rate. So if rates rise, so will their repayments.

A variable home loan can be more difficult to budget for, but tends to be more flexible so they may be able to:

make extra repayments to pay their home loan off faster.
access these extra repayments via a redraw facility.
open an offset account, which they can link to their home loan to reduce interest.

Split loans

A split loan can help to manage the risk of higher repayments by letting your customers fix some of the loan and leave the rest variable. This could give them the best of both worlds, as a split-rate loan allows them to have rate and repayment certainty on the fixed-rate loan, while taking advantage of any interest rate reductions on the variable-rate loan.

2. Check their spending

Creating a budget could help your customers get across how much income they’ve got coming in, how much they need for the essentials and where the rest of their money might be going.

This will help them identify if there’s any room for movement and if they could potentially add a little bit extra to their repayments. AMP’s Budget calculator could help them crunch the numbers.

Rising home loan interest rates explained

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What can your customers do to reduce rising rates impacts?

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