The year 2023 has marked a significant chapter in the history of the Reserve Bank of Australia (RBA), with a relentless drive to elevate the cash rate to its highest point in over a decade. This move has been orchestrated by the RBA as a formidable weapon against the looming threat of inflation. Just last year, in May, the cash rate stood at a mere 0.1 per cent, but it has since embarked on a swift and unprecedented ascent, surging 12 times within a span of 16 months. As of now, the cash rate stands tall at 4.1 per cent.
Amidst the RBA’s unyielding efforts to rein in consumer spending, borrowers find themselves confronted with a plethora of risks arising from this series of cash rate hikes. In this article, we will delve into these risks and explore strategies to mitigate them.
Imprisoned by Your Mortgage
One perilous scenario that borrowers could encounter is being ensnared in what’s colloquially known as a ‘mortgage prison.’ This grim predicament unfolds when borrowers lack the equity or fail to meet the serviceability requirements necessary for refinancing their home loans. In essence, they find themselves trapped in their existing mortgages, even if these are no longer viable or suitable for their financial circumstances. The perfect storm for mortgage imprisonment brews when the value of one’s property dwindles while interest rates surge.
The Peril of Negative Equity
The escalation of the cash rate can exert downward pressure on property prices, casting some properties into the treacherous realm of negative equity. Negative equity is the unfortunate situation where the market value of your property plummets below the outstanding balance on your home loan. In simpler terms, you owe the bank more than your property is worth. For example, if your property’s value was once $800,000 and your loan balance was $720,000, but the property’s value dips to $700,000, you find yourself mired in negative equity. This predicament can particularly haunt homeowners who secured large loans at low-interest rates with minimal deposits, especially if their interest rates have spiked and their property values have tumbled.
The Conundrum of Fixed-Rate Loans
During the COVID-19 pandemic, the popularity of fixed-rate loans surged as borrowers seized the opportunity presented by historically low interest rates. Many borrowers opted for extended fixed-rate terms, while banks dangled fixed rates enticingly below variable rates. Fast forward to today, and a significant number of these fixed-rate terms are on the brink of expiration. According to the RBA, 2023 will witness 880,000 fixed rates expiring, followed by 450,000 loans in 2024. These borrowers now face the stark reality of substantially higher interest rates. The pressing question that looms before them is whether to re-fix at a higher rate or allow the loan to revert to a variable rate. Economists are divided on the future of the cash rate, making this decision all the more daunting.
Mitigating the Risks of a Fluctuating Cash Rate
Build Up Your Equity
There are several strategies to consider:
– Increase Repayments: If your budget allows, boosting your repayment amount, even slightly, can expedite the process of building equity.
– Frequent Repayments: Opt for weekly or fortnightly repayments to chip away at your mortgage more aggressively.
– Make Extra Payments: Bolster your equity by injecting lump-sum payments into your home loan or making regular extra contributions.
– Renovate: Enhance your property’s value through renovations, which can subsequently bolster your equity.
Explore Refinancing
Refinancing could be your lifeline, enabling you to secure a more competitive interest rate or a home loan with features designed to save on interest costs and expedite mortgage repayment. If you find yourself in the confines of mortgage imprisonment or the abyss of negative equity, reaching out to professionals to explore refinancing options becomes paramount.
Seek Professional Assistance
Don’t hesitate to seek expert advice. The sooner you reach out, the broader the range of choices available to you. Reach out to financial experts who can tailor a plan to your unique circumstances.
As the Reserve Bank of Australia continues its battle against inflation through the elevation of the cash rate, borrowers must remain vigilant and proactive in safeguarding their financial well-being. The challenges may be formidable, but with strategic planning and expert guidance, they can be surmounted.
Get in touch and we’ll take a look at your specific circumstances.