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Interest rates are on the rise and more rate hikes are predicted. Many borrowers may be anxious to lock in a fixed rate to avoid multiple rate hikes, but will it really make them better off?
How much will variable interest rates rise?
While there is no way to predict interest rate movements with 100% accuracy, economists at Australia’s largest banks have warned that in 2023 we could expect cash interest rates to start at a “2”. This could mean that home loan interest rates could rise by 2-3% over the next two years.
This is consistent with what RBA Gov. Dr. Philip Lowe said in a recent interview on raising the key interest rate to 2.5 percent; right in the middle of the inflation target range of 2 to 3 percent:
“How quickly we get to 2½ percent, and indeed whether we get to 2½ percent, will be determined by events. The Board of Directors of the Reserve Bank meets every month. We have a huge wealth of data to analyze at each of our meetings when deciding how fast to go and how far to go.”
It remains to be seen exactly what impact these rate hikes will have on inflation, and what actions the RBA will take based on these impacts going forward.
A RateCity analysis, based on forecasts by the big banks, found that the average owner-occupier paying a floating rate could be paying interest as high as 5.14% by 2023. This could result in an increase in mortgage payments of over $600 per month.
When will variable interest rates fall again?
It is important to remember that some of Australia’s major banks are forecasting that the RBA will eventually cut interest rates once inflation is brought back under control.
Gareth Aird, Head of the Commonwealth Bank’s Australian Economics Division, said in a June 2022 report that while the RBA is keen to bring inflation down quickly with rate hikes of up to 50 basis points, “this will come at the expense of aggregate demand growth, particularly private consumption.”
“Our expectation is that economic momentum will slow significantly in 2023 under the weight of contractionary monetary policy. Therefore, we expect monetary easing to be on the agenda in the second half of 2023. We have planned rate cuts of 50 basis points for the second half of 2023.”
AMP Economist Diana Mousina, said in an interview with the ABC that we are already seeing the economy react to higher interest rates, and if it reacts faster than the RBA expects, then rates may not need to go to 2.5 percent.
“But along the way we’re going to have some economic pain. We believe that the unemployment rate will increase in 2023. And we actually see the RBA cut interest rates again in the second half of next year when inflation slows and you start to see that weaker growth story. And there will be room for the RBA to hopefully cut as inflation slows.”
Keep in mind that even if the RBA cuts cash rates in late 2023 or 2024, there is no guarantee that every bank will immediately pass that rate cut on to its home loan customers. Banks and lenders may also choose to raise or lower their home loan interest rates outside of the RBA cycle in response to other economic factors.
What does fixed interest look like?
Looking at the RateCity database, the average fixed interest rates for owner-occupiers at the end of May 2022 were:
- 1 year fixed: 3.82 percent
- Fixed 2 years: 4.40 percent
- 3 years fixed: 3.82 percent
- Fixed 4 years: 5.26 percent
- Fixed 5 years: 5.32 percent
So while the average home-occupier could be paying 5.14% interest through 2023 with a variable rate, switching to a 4- or 5-year fixed rate could potentially mean paying an even higher rate. And if there is a rate cut in late 2023 or 2024, fixed rate borrowers may not benefit if lenders pass through that rate cut.
If you’re considering switching to a fixed-rate home loan to avoid interest rate hikes, it’s important to compare fixed-rate home loan options before taking the plunge and do some math to gauge whether you’re likely to be better off financially.
What is the best choice for me?
The best choice between a fixed or variable rate depends on your personal financial situation.
For example, if you’re more concerned with keeping your household budget stable and stable, a fixed rate could be attractive as long as you’re confident you can comfortably afford the repayments. You also need to consider that at the end of your fixed term, your loan would revert to a floating rate and the repayment rate could be higher than your previous fixed rate. Also, refinancing your home loan during the fixed term can mean you have to pay expensive interruption fees.
While a variable interest rate would increase the cost of your repayments if interest rates rise, it’s also possible that you’ll get a small relief if interest rates fall in the future. Also, adjustable rate home loans offer more flexible repayment features, such as additional repayments, a redraw facility, and an adjustment account, than many fixed rate home loans. These features could provide more options for managing your home loan repayments, even when interest rates are rising. Of course, home loans with more features and benefits also often charge higher interest rates and fees than simpler, no-frills home loans.
Whether applying for your first home loan or refinancing an existing mortgage, it’s important to compare home loan options before making your decision. If you’re unsure whether a fixed or variable rate better suits your needs, you can consult a mortgage broker for more personalized advice.