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A rise in your mortgage repayments is exactly the kind of event that should see you digging out the budget to see how it's going to affect your regular household finances. (Never done a budget? Or need a refresher course? Refer to our How to prepare a budget fact sheet.)
Okay, so we know that for those with a variable rate home loan, rising interest rates will mean you'll pay more on your home loan – we can work out that much without the help of a budget. But you do need a budget to help you determine where the extra money is going to come from in order to keep up with the new repayment levels.
Once you've done your budget to factor in your new repayments – what does it tell you? Is it telling you that things are getting too tight? Are you going to have to dip into your regular savings to meet the higher repayments? Perhaps you're able to cope right now, but you're not sure how you'll cope if rates keep going higher. Or, are you already unable to make the repayments at the current level?
Your budget will soon let you know where you stand. If it's telling you that you're going to need to tighten your belt, it's time to start rethinking your spending.
On a day-to-day level, how much more money would be left in your budget if you could reduce your spending? Are there some 'optional extras' that you tend to buy for yourself or your family that you don't really need? While buying one less takeaway coffee every week isn't going to make much difference to your mortgage, if you can reduce a number of these expenses, it will soon start to add up.
So, as well as seeing how much you could save by living with less latte in your life, also consider:
- BYO lunch to work rather than buying expensive takeaway;
- Rather than buying a magazine each week or month, consider a subscription (usually a cheaper way to purchase a regular publication), or consider doing without the publication until things get a little easier financially;
- Shop smarter when you do your grocery shopping – shop once a week, take a list and stick to it, and consider cheaper brands and cheaper grocery outlets;
- Consider taking public transport to work instead of driving the car – you'll save on petrol and parking. And if you're still using the car, fill up with petrol on the day of the week when it's cheapest in your area (often Monday or Tuesday, but the Australian Consumers' Association website, www.choice.com.au, can tell you more – just enter "petrol" into the search engine on their home page);
- If you eat out fairly regularly, eat out less often;
- If you and the family love to catch a movie, see if the local cinemas offer a half-price night instead of paying full price, and cut back on how often you go... a DVD at home is a lot cheaper;
- Do you really need that pay-TV subscription? How much would you save if you could go without?
Of course, if you need to take a more hard-line approach to reducing your spending, for example you might already be doing all the above but you still need to free up more funds, you still have options. First of all, keep doing what you're doing in the way of cracking down on the optional extras like those mentioned above, but also consider some of these savings opportunities.
Sometimes, substantial savings can be made by looking at the financial products and services you use. The following list provides some options for cutting back on some significant, ongoing expenses.
- Cut back to just one credit card (or no credit card at all). For starters, you'll only pay an annual fee for one card (look for a card with a low, or no, annual fee).
- If you carry an ongoing debt on your credit card and therefore pay interest on that debt, consider aiming for a card that will give you a low rate of interest to help you reduce that interest burden in your repayments.
- If you always pay your credit card off in full each month, consider aiming for a card with a low or no annual fee.
- Forget about reward programs for now – these often mean a higher annual fee or a higher interest rate, and might tempt you to buy more than you really need just to qualify for more rewards (which are also usually items that are not essential).
- In an ideal world, we could probably all do without credit cards and we wouldn't incur any of the costs they can carry. But if you really need a credit card for certain things, only use it when you really have to. Leave it at home for all those other times – don't let it tempt you into buying items that you simply don't need, or worse, can't really afford to be buying.
If you're dealing with mortgage repayments as well as repayments on other loans, such as a car loan or a personal loan, investigate your options for wrapping some of your smaller loans into just one product. The aim of consolidating your debts is to make sure you pay less interest on your total debt overall.
But do your homework. Unfortunately, not all lenders and debt consolidation agencies are as scrupulous and open as you'd like to think. Beware of consolidation products that offer a low interest rate in the first year, only to hit you with a much higher rate at the end of that period (these are called honeymoon rates) – you might end up paying more in interest than you do now. And beware of products that offer an attractively low interest rate, only to hit you with a series of ’hidden' or difficult-to-interpret fees and charges...these could also cost you more in the long run.
When consolidating, visit reputable financial institutions and lenders whose products are clearly explained in their brochures and website material, including all the applicable fees and charges. And if you've got any questions, just ask – you need to make sure you're completely comfortable with any financial product you buy and any contracts you enter into, and part of that is being sure you understand everything that's involved.
As well as cracking down on your spending across the board, you may be in a position to benefit from refinancing your mortgage. Refinancing essentially means closing your existing home loan and transferring to another type of home loan, either with the same lender or a different one. Reasons to refinance can include switching to a fixed rate loan from a variable rate loan (or vice versa), extending the term of your loan (if your current loan won't allow you to do so), or looking for a lower interest rate and lower ongoing fees.
Regardless of the underlying reason, if you're thinking about refinancing, you'll need to consider the underlying costs very carefully – not just the costs that may be associated with opening up a new loan, but also any costs associated with exiting your existing loan. Depending on the type of loan you have, you may incur a penalty for closing down the loan early (i.e. before the full term of the loan has expired). If you do pay extra money for closing your loan early, factor that in to your overall calculations – it may mean that the true benefit of changing to a cheaper loan won't actually see you paying less money for a few months or even longer.
A reputable mortgage broker can help you determine what the costs of leaving your existing loan contract will be, as well as the options for taking out a new loan contract. A good quality mortgage broker won't charge you a fee – instead they will get their payment through commissions from the financial institutions whose products they recommend. (Check that they get the same level of commission from all the financial institutions on their books – that way you know they won't be tempted to offer you products simply because that particular lender pays them a higher commission.)
When interest rates start to rise, there's often a race to move from variable rate loans to fixed rate loans. Variable rate loans generally allow you to make ad hoc or regular additional repayments on your loan and may allow you to pay your loan off sooner than the agreed term (although note that penalties may apply if you pay the loan out very early, for example within the first four years), but their interest rates are tied to movements in prevailing market rates, which means the rate you pay increases if market rates increase (which is the situation we're in at the moment).
Fixed rate loans, however, provide the benefit of predictable repayments. The interest rate you pay is locked in for the fixed period when you take out the loan, and is not affected by changes in interest rates, and therefore your repayments are locked in, too. However, you generally can't make extra repayments on a fixed rate loan (which means that if you have a windfall, or if you simply have a very disciplined approach and want to make extra repayments to reduce your home loan earlier). Also, these days, the fixed rate doesn't necessarily apply to the entire life of your loan –often it's to a certain period, such as three, five or eight years.
Another factor to consider when looking at these two types of home loan is the fact that fixed rates usually come at a premium – they're typically higher than the standard variable rate. So, you are essentially paying a premium for certainty. And of course, should prevailing interest rates go down, your fixed rate won't come down (unlike a variable rate), because you're locked in to that rate for the period of time specified in your loan contract.
Again, an independent mortgage broker can help you assess your options when it comes to fixed rate loans versus variable rate loans.
Another option to help reduce the burden of increasing repayments is to reduce the term of your loan. For example, if your loan currently has a term of 20 years, if you increase the term to 30 years, your repayments will come down in the meantime. Of course, the flipside of this short-term reduction in your regular repayment is that you'll be living with a mortgage for longer. Of course, if this makes the mortgage more manageable, it may be worth it.
If you're experiencing severe financial hardship, it may be possible to access a certain amount of your superannuation savings early, savings which would otherwise not accessible until you reach retirement age. But while it may sound like the answer to all your financial problems, it may only be a temporary fix but with lasting consequences for your future financial security.
To qualify for early access to your super due to severe financial hardship, you must be unable to meet your reasonable and immediate family living expenses. In addition, you need to have already been receiving a government support payment for at least 26 continuous weeks (if you are over age 55, the qualifying period may be reduced). If you do qualify (your super fund or Centrelink may be able to help you determine this), limits can apply to the amount that can be withdrawn.
If you do qualify for early access to your super, consider the following:
- Have you exhausted all other reasonable financial options before taking this course of action?
- If you qualify to withdraw some of your super, how long will this allow you to meet your mortgage repayments? Will it permanently get you out of a difficult financial position, or will it simply delay the inevitable?
- Super is money for your retirement. If you access it now, what impact will that have on your finances once you've retired and become dependent on whatever's left to meet your ordinary living expenses?
The decision to access your super early is not one to take lightly and there are a number of important factors to weigh up. Before going down this path, you might want to seek the support of a financial counsellor in order to explore the other options available to you, options which will potentially have much less of an impact on your future financial security.
Beware of schemes offering you early access to your super – usually for an upfront fee or for a percentage of the amount released. These scams are run by fraudsters posing as financial advisers, or by unscrupulous financial advisers themselves, who make false applications to your super fund to have the money released. In some cases, the perpetrator then takes off with the proceeds. Those targeted are usually under age 55 and, unfortunately, are often experiencing financial hardship (which makes the scheme sound all the more tempting).
No matter how tempting, the scams are illegal. If you do ever see any of the money, it's money that you no longer have for your retirement, and you are likely to be left with significant tax penalties (and legal penalties). So if you're under age 55 and are offered early access to your super, don't sign up. Instead, report the organisation to the Australian Securities and Investments Commission (ASIC) – an independent regulatory body – they'll soon tell you if it's legitimate. Chances are it is not.
If you're refinancing or about to get a new home loan, here are just a few starter tips to help you safeguard your finances in this rising interest rate environment.
Make sure you know exactly where your finances are at, and make sure you have a budget in place that will help you not only determine what level of mortgage payments you can afford to take on, but then stick to those repayments while also meeting your other financial commitments. Whenever there's a change in your financial situation, for example a pay rise, a reduction in income, an increase in your mortgage repayment, or the addition of another debt, update your budget so that you've always got a clear picture of where your finances are at.
Have a full understanding of how your repayments will work, how often they need to be made, and how much they will be. Also be aware of any other costs that may be associated with your mortgage, such as regular account keeping fees. Depending on the type of home loan you go for, you should also be aware of any costs associated with additional facilities such as redraw and offset accounts etc. If you've used a third party such as a broker to help secure your mortgage, also be well aware of what fees you are paying them, if applicable.
It's impossible to say exactly what interest rates will be in six months' time, a year from now, or five years from now, but it is possible to get an idea of what your repayments would look like if rates were to continue rising. When taking out a mortgage, work out what your repayments would be if interest rates were higher than they are now. Would you still be coping if rates were 1% higher, or 2-3% higher? And what if you were to experience a reduction in your take-home pay? While you're at it, stress test your budget to see how a reduction in income, or a temporary or prolonged loss of income, might affect your repayment situation, and whether you've got any room to move in your budget to help get you through.
It's pretty fundamental – if you can't afford to pay it back, don't borrow it in the first place. It's a difficult housing market right now, and the desire to own your own patch of dirt can be a powerful one. But buying a home, only to see it slip away due to unaffordable repayments, can be devastating. When you're looking to buy, the stress test (above) is a helpful indicator of how your finances would cope with varying mortgage amounts at varying interest rates. If your calculations indicate that there's a limit to what you'll be able to comfortably afford, pay attention to that limit and set your sights on something that you can afford.
We've mentioned a number of agencies and professionals in this article that may be able to provide support or advice when it comes to your finances. Here are some contact details:
Website: www.fido.asic.gov.au
Phone: 1300 300 630
Website: www.choice.com.au
Website: www.bfso.org.au
Phone: 1300 780 808
Website: www.centrelink.gov.au
Phone: 1800 050 004
For a list of Australia-wide financial counselling services, refer to our Troubleshooting for your finances fact sheet.
The information in this material is intended as general information only; it is not intended to be a substitute for professional advice and should not be relied upon as such. The material has been prepared without taking into account your objectives, personal needs and financial circumstances and you should consider whether it is appropriate for you. Australian and New Zealand Banking Group Limited ABN 11 005 357 522.
MoneyMinded meets the Financial Literacy Foundation's Essential Elements eligibility and assessment requirements and has been assessed as being of good quality.
MoneyMinded offers independent and unbiased consumer education. Its development was initiated and funded by ANZ with contributions from the community sector and education experts. It does not contain any ANZ branding or promotion of financial products and services.
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