Rising Tide Blog

Interest rates are moving, how do I prepare?

Posted by Sam Gawenda

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To fix or not to fix is a common question people are currently asking, and with good reason. We recently released this article to help people with that decision.

In this blog, we want to have a closer look at the numbers. But before we get into the nitty gritty, the first thing we would encourage you to do is think about what you are trying to achieve. Examples may be:

  • Create habits that set you up for increased repayments
  • Build up a cash buffer
  • Pay the least amount of interest in the short term
  • Help you sleep at night due to certainty of repayments
  • Ensure your other goals aren’t disrupted when rates move

Over the past few months, fixed rates have increased dramatically, and you can now expect to pay around 1% more for a fixed rate compared to variable. This can be an indication that the variable rates are going to start trending upwards as well.

We often like to ask, ‘So what?’

How do you think about this information and what can you do to prepare for this? Understanding what you’re trying to achieve will anchor you in an appropriate strategy and help you to interpret the numbers. While your initial response might be to fix your loans, it’s important that we explore this a little.

The scenario:

You have a $600,000 home loan

Your variable rate is 2.5% so you are paying $15,000 in interest each year.

If you were to fix for 2 years at 3.5% you would be paying interest of $21,000 per annum.

Now, let’s run with a hypothetical that the variable rate moves 0.25% each quarter over a two-year period and compare that with fixing in for two years now at 3.5%.

Variable interest rateInterest payable on variable rateFixed interest rateInterest payable on fixed rate
Quarter 12.50%$3,7503.50%$5,250
Quarter 22.75%$4,1253.50%$5,250
Quarter 33.00%$4,5003.50%$5,250
Quarter 43.25%$4,8753.50%$5,250
Quarter 53.50%$5,2503.50%$5,250
Quarter 63.75%$5,6253.50%$5,250
Quarter 74.00%$6,0003.50%$5,250
Quarter 84.25%$6,3753.50%$5,250

Even factoring in a 1.75% increase to the variable rate over the two-year period, the variable is still (marginally) cheaper when you look at the cumulative interest cost over the period.

There is much more to making the decision between variable and fixed than just the interest rate, so understanding this basic analysis will help you to look beyond the difference in the rates today. Without doubt, the rate rises are coming soif you are going to let it ride on variable, we highly recommend you plan for future rate rises and here is one way to do so:

Monthly P&I (Principal and Interest) repayments on a $600,000 loan at 2.5% are $2,370 – at 3.5% these repayments are $2,750. A simple way of planning for rate rises is to save the $380 difference per month either into an offset account or loan redraw.

By doing this, you will achieve three important things:

  1. Create spending habits that allow for increased repayments
  2. Build up a buffer of cash ($4,560 over a 12-month period)
  3. Reduce interest payable as funds are sitting in offset/redraw against your variable loan

If you want or need some help planning for these impending changes and balancing your goals and cashflow, make sure you reach out to one of the team and we can help.

Please note: All numbers in this blog are estimates and to be used as a guide only.