How homeowners can prepare for rising interest rates
Experts share their tips for managing interest rate hikes.3 February 2022
Around two-thirds of Kiwi mortgage holders are going to be re-fixing or opting for a floating rate in the next year so the prospect of rising mortgage interest rates alongside OCR rate rises may be keeping some awake at night.
Interest rate rises aren’t something that you can control but there are some steps you can take to cope in a rising interest rate situation.
First of all, if these interest rate rises are going to make you financially uncomfortable, you need to discuss this with your lender now, says Tom Hartmann, managing editor of the Commission for Financial Capability’s website, Sorted. This action will tick off a whole set of internal programmes the bank has in place to accommodate mortgage holders at a time like this.
“People have the right to do this when conditions change,” says Tom.
You may prefer to speak to an independent personal finance adviser or to a mortgage adviser as well.
If you’re anxious, it wouldn’t be an overreaction. As Loan Market mortgage adviser, Mikey Smith says, this is the fastest spate of rate rises in NZ history. If your mortgage went from the low 2s (%) to 4s (%), that’s a 100% change in the space of three to six months. And there’s more pain on the way, with another 1% to 2% to go.
When you’re applying for a home loan or you’re re-fixing, you really want to have a mindset of thinking about what you can handle in the next three years, says Mikey. People might say if interest rates go up I can fill up the house with boarders, but that’s not going to work if you’ve got kids.
When sitting down with clients looking to re-fix their mortgages, he’s often recommending what he calls “splitting and hedging”, in other words, splitting the loan over a range of terms, say for one year, two years, and four years, for instance, and therefore hedging your bets on what’s ahead.
Do the calculations and know what could be ahead
Something which can really help you get your head around a rising interest rate environment is to face your fears and do the calculations on what each interest rate rise will mean to your household finances.
A 1% interest rate increase on a loan of $1 million will mean a $10,000 a year increase in interest which is $192 a week, says the Loan Market mortgage adviser. Mikey will sit down and go through the specific calculations with clients on a regular basis.
The Sorted.org website also has a mortgage calculator which can help you with this “stress testing,” telling you how much your regular payments will be at different interest rate levels.
Plugging in some numbers there can be part of you being a “responsible borrower,” says Tom Hartmann.
Seeing the exact amount, you can see what the impact will be and that’ll give you an idea of the change and what you need to do to plan ahead. You can say: “If it does go to this, where can we adjust?” says Tom.
Lenders are doing this kind of stress testing when considering your mortgage application, typically putting in a buffer of around 3% or 4% on top of the actual rate you’ll pay to see if you can still afford a series of interest rate hikes.
Another area where you can take action prior to another interest rate rise is looking at your debt. With your credit card debt, for instance, we often underestimate how much interest we’re paying, says Tom.
“You may feel rich because you’ve got a valuable asset in your home but it’s possible that you’re leaking money in interest,” he says. Credit cards can be charging monthly interest of 18%, 19%, or 20% without you taking much notice.
You have options but what you do next has consequences
Financial adviser and enable.me director, Hannah McQueen says, if you’re genuinely concerned financially after you’ve taken stock of your mortgage situation in light of rising interest rates, you have a number of options. You can talk to the bank about extending the term of your mortgage to lower the repayments, or you can ask to take a break from repayments while you get your “financial house” in order. You could go interest-only for a period or break the mortgage now to lock in the rates for a longer-term contract.
“One year fixed rates could sit at close to 5% by this time next year so if you’re locked in rates in the twos, that could be roughly twice the rate you’re paying now. If that figure is going to hurt, we need to address it before your current term expires,” says Hannah.
Even if that means your rate will be higher than what you’re currently paying, because waiting for the mortgage to expire will certainly trigger higher rates anyway, she adds.
The enable.me director cautions that all these options have costs and consequences so she advises getting independent financial advice to help guide you through it.
With inflation high, nows the time to ask for that pay rise, and make a savings plan.
At the same time, you need to look at how to improve your financial management, she adds. Making savings is something you have the most direct control over and adding to your income is another avenue.
Getting a pay rise at work should be a real focus, says Hannah.“With inflation running hot, if you don’t get a pay rise, your income has fallen in real terms,” she points out.
If your employer doesn’t have the funds to pay you more, then discuss some other options you could benefit from, suggests Hannah. This might include buying into the business, getting ongoing education or professional development, a car park, or more flexible hours which would allow you to cut down on childcare costs. There are multiple ways to work this.
“You may also be able to create a financial buffer by setting up a side hustle or even selling off unused items – anything that’s going to give you some financial resilience in the face of rising costs,” says the financial adviser.
Mortgage holders looking for stability ahead
As people renew their mortgages in the next year, they might want to look for a term that gives them the stability of payments over a period of time rather than choosing the cheapest rate available, suggests Infometrics principal economist Brad Olsen.
A one-year term may be the cheapest rate but do you want to be renewing in a year’s time when rates are likely to still be on the rise, from what the Reserve Bank has indicated.
A number of households are likely to be more attracted to two to three-year terms, says Brad. “Some households will crave a bit more stability. The rate may be higher than the one-year rate but if it means your household knows how much you’ll be paying for the next two years, it could be worth it.”
Meanwhile, Brad agrees with Hannah that asking for a raise is timely given rising living costs.
“The labour market is tight. If you’re sitting there working part-time, there could be the ability to up some hours,” he adds.
Think about dialing down the spending
The reality is, most people can afford the interest rate rises, says Brad, but there will be some belt-tightening going on in Kiwi homes in 2022. Over the last two years, people have been spending a fair amount, so it’s more about cutting down on discretionary spending – people have been taking holidays, buying bigger ticket purchases like boats, spa pools, home renovations, furniture, and electronics, he says. There will be a pull back to normal.
“I think it’s been quite a sugar-run over the past three years that will naturally come back for households, there’ll be a hunkering down this year,” says the economist.
People won’t need to be ultra frugal but they’ll make a prudent start to the year and keep a closer eye on the bank statement, he predicts.
Cutting down on discretionary spending will keep you in good stead as interest rates rise.
Chief property economist Kelvin Davidson agrees there are good reasons not to panic. Keep in mind, even if you’re rolling over from 2.5% to 5% mortgage rates, the bank has tested that you’re able to pay a 6.5% or 7% rate,“ he says.
Hedging your bets over a number of terms is fairly clever, he agrees. There’s enough uncertainty about the interest rate path to hedge bets that you don’t fix forever, he explains.
And while there’s a lot of water to go under the bridge, rates could go down again later in 2024 in certain circumstances. He doubts they’ll go back to the historic low of 0.25% however.
Big picture thinking
And something to remember, says enable.me’s Hannah McQueen, is that, in the long term, the thing that’s going to have the biggest impact on how much interest you pay in total, isn’t the interest rate, but the pace at which you repay the debt. Interest rates are still low by historical standards so now is the time to make the most of the opportunity to make progress faster.
“What would life look like if you could get mortgage-free in 10 years instead of 25 or 30?” she asks.
Just something to think about.