This is part two of a two-part column by our columnist and the author of How to Get Mortgage-Free Like Me.
Yesterday was the number crunching: how much rate rises could hurt your hip pocket. Today is how to fight back against rate rises: you DON’T just have to wear the RBA cost impost.
Read part one: How much extra your mortgage will now cost
Thanks to a pandemic price war, the differential between the average Big Bank mortgage interest rate and the cheapest quality loan has blown out to 266 basis points.
That is equivalent to more than 10 (25 basis point) rate moves.
Read more from Nicole Pedersen-McKinnon:
Putting that another way: you could give yourself 10 rate cuts today… if you ditch the big four banks and move to the best-in-market.
Here's how to do it, and two more tips to fight back against rate hikes.
Hike fight 1: Ditch and switch
Despite the official interest rate having been at a COVID-induced emergency setting of 0.1 per cent for almost two years, and all lenders dropping their home loan rates to some degree, the Big Four banks remain hugely expensive. For those who don’t know to ask for a discount, that is.
Their average undiscounted interest rate is 4.51 per cent.
Meanwhile, the cheapest comparable loan also underpinned by an authorised deposit-taking institution (I’ll explain why that is important in a sec) charges just 1.85 per cent (Well Home Loans).
And that’s that 266-basis-point – or 10-rate-cut – interest opportunity.
Snare this rate relief on a $500,000, 25-year loan and your monthly repayments instantly drop by $699 a month.
See what I mean about "forget the RBA"?
But here’s my real recommendation: Secure this discount but then simply keep your repayments at their existing, higher-than-necessary level. You do what I call ‘Up stumps but still stump up’.
This would slash your overall interest outlay from $334,601 to just $85,945.
However, not only would you save nearly $250,000 but you would shave almost seven years off your loan term. And remember, for not one cent more than you are used to paying.
Read more about how to save on your mortgage:
Hike fight 2: Throw a fix in the mix
There, I chose my words carefully. I only ever advocate fixing half of a mortgage and only for a maximum of three years.
Normally about 15 per cent of new borrowers opt for fixed rates but this leapt to about 50 per cent in recent times as borrowers were spooked by a forecast rate spike.
The trouble is almost every lender in the market had increased its fixed rates already, in anticipation of the Reserve Bank’s move.
The time to fix is not once rates start to rise, it’s before they are expected to.
Having said that, interest rates may still go higher than the current fixes that are out there (datahouse Mozo says the leading two-year fixed interest rate is 2.45 per cent from Orange Credit Union, followed by Australian Mutual Bank at 2.68 per cent).
Which brings me back to my "fixing half" comment.
One of the reasons is that fixed rates generally do not come with quality offset accounts - even if there is one, it may not be dollar-for-dollar or may be at a reduced interest rate.
Offset accounts are an incredibly powerful debt-reduction tool that essentially let you use every dollar that passes through your hands twice.
But an offset account is not just a genius debt-reduction tool, making any overpayments into offsets both protects your future and preserves your flexibility.
The final reason it’s prudent to lock in only a proportion and only for a limited period? Anyone can get interest wrong. Rate expectations turn on the head of a pin; we saw that starkly when confronted two years ago with an international health crisis.
As much as rates are expected to rise now, they could start falling again, sooner than expected. And you don’t want to be held to a higher-than-market rate.
What else can you do to rail against the RBA?
Hike fight 3: Build a home loan war chest
There is no need to panic. However, it’s possible your borrowings are significant and rate rises will hurt – see part one of this column for exactly how much.
The smartest, safest way of heading this off is to stash cash.
Get ‘ahead’ on mortgage payments. But don’t pay extra directly into your mortgage. This is the mistake I alluded to earlier that leaves you exposed: a lender could recalculate your home loan balance and/or freeze any redraw facility if you get into financial trouble.
To round out that explanation: some lenders offer only fake offset accounts that are redraws in disguise… that’s the important difference with an authorised deposit-taking institution, which also carries the Australian Government Deposit Guarantee.
So instead of paying extra ‘all in’, just the required monthly amount should go into your loan and you should make ‘overpayments’ into an attached offset account. Note that your interest savings are identical but you retain full, flexible access.
If you don’t already have one, you should also slowly and surely build a ‘Holy Sh*t’ fund of preferably six months’ salary.
Then, if rates move dramatically higher (or other financial ‘sh*t’ happens), you will remain relaxed and economically comfortable. You can drip feed your mortgage the minimum that is contracted, from your offset.
Your rate-hike fight can start today.