How rising interest rates could affect fixed-rate mortgage holders

Borrowers who locked in record-low fixed interest rates below 2 per cent in the past few years are likely to face a substantial increase in mortgage repayments when their fixed terms end and they roll onto their lender’s standard variable rate. 

The big banks now predict the official interest rate to rise by between 1 and 2 percentage points within the next two years, which could push typical variable rates to between 4 and 5 per cent.

While many borrowers with fixed-rate loans still have time to enjoy low and steady repayments, preparing for rising rates now could put them in a better position when their fixed terms end.

How are fixed-rate mortgage holders affected by rising interest rates?

Fixed-rate mortgage holders may be insulated from initial increases in the cash rate, but they won’t remain unaffected forever, said ANZ senior economist Felicity Emmett. 

“In 2020 we could get rates for either a three-year mortgage or two-year mortgage for below 2 per cent,” she said. “Over the next couple of years, we’re going to see a number of people coming off those fixed mortgage rates as their term expires and roll onto variable mortgage rates, and those rates will be significantly higher.” 

Due to the extraordinary measures the RBA took during the pandemic to help reduce borrowing costs, an unusually high share of borrowers are now on fixed-rate mortgages, Emmett said. 

“If we look back to 2019, it was around 15 per cent of people taking on these [fixed] rates,” she said. “But, through 2020 and into 2021, we saw that really ramped up quite a bit, with the peak of about 46 per cent of people taking on fixed-rate loans in the middle of 2021.” 

As a result, many home owners could experience a significant increase in their repayments over the coming months and years. 

“This is actually going to be a very common issue among borrowers,” Emmet said. “[That is,] having this quite significant lift in repayments over the next couple of years.” 

For a borrower with a $500,000 home loan who fixed at 2 per cent, a sudden increase to their interest rate of between 2 and 3 percentage points when their fixed rate ends could mean their repayments would increase by between $539 and $836 per month, based on calculations using the Domain Home Loans Repayment Calculator.

While some home owners have experience servicing their mortgage at interest rates much higher than today, many first-time borrowers have only ever seen their repayments decrease as a result of the RBA’s extraordinary stimulus measures through the pandemic. 

“Interest rates have been very low for a long time and we know this [increase] will be a new experience for some customers,” said Andy Kerr, executive of home ownership at NAB. 

What can fixed-rate mortgage holders do to prepare for rising interest rates?

While the prospect of an increase in mortgage repayments can be daunting, there are ways fixed-rate mortgage holders can prepare before their term ends. 

Review your home loan 

Whether your fixed-rate expires in six months or six days, it’s worthwhile having a conversation with your broker to review your current rate and loan structure, said Lianna Mills, senior home loan specialist at Domain Home Loans. 

“At any point in time your loan can be reviewed,” she said. “With all the uncertainty right now, understanding what your options are is important.” 

Reviewing your home loan now could help you determine whether you can refinance to a lower interest rate, or re-fix your rate for the certainty of future repayments. 

Get ahead on your home loan

If you can, making additional repayments to your mortgage now could help soften the impact of an increase in repayments in the future.

While borrowers on a fixed rate are likely to have a cap on how much extra they can put towards their mortgage repayments, it’s worth checking what that cap is and considering making extra repayments now, where possible, Mills said. 

“Making extra repayments on your fixed home loan, ensuring you’re within your extra repayment cap, provides a buffer for when rates increase,” she said. 

“This can provide some comfort, as your extra repayments will likely result in your home loan being paid in advance.” 

Consider refinancing 

For borrowers who prefer the security of their current fixed home loan, re-fixing or refinancing before their fixed term ends may be beneficial, Mills said. 

“Initially, you might see an increase in repayments, but the view is that you will be in a more secure and stable position down the track.” 

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How high will interest rates rise?

While all of Australia’s big four banks lifted mortgage rates in line with the RBA’s 25-basis-point increase, there’s little consensus on exactly where and when the cash rate will reach its peak. 

NAB and Westpac have both predicted the cash rate will peak at around 2.6 per cent. Westpac expects this will happen in early 2023, while NAB expects the peak will be reached towards the end of 2024. 

ANZ has predicted a slightly lower peak of 2.25 per cent by the middle of next year, while CBA expects the cash rate to top out at 2.1 per cent by late 2022, the lowest expectation of the four major banks.

It’s expected the Reserve Bank will be strongly informed by how the economy reacts to its monetary policy. 

“I think they’re going to sit back and watch to see what impact those moves have actually [had] on the economy, ” said Alan Oster, chief economist at NAB. 

“If the economy stays really strong, they might go a bit further.”