It has been very well reported that many mortgage holders will soon be paying much higher interest rates when their fixed rate terms expire. It is estimated that $478 billion worth of fixed rate mortgages are due to expire in 2023.
In addition, borrowers may also have to navigate the end of an interest only term, which typically apply to investment loans.
This blog sets out our advice on how to navigate these changes.
What are your options?
Fixed rate expiry
If your fixed rate is maturing, you have two options. You can re-fix your interest rate for another term or allow the interest rate to roll over onto a variable rate.
Current fixed rates range between 5.39% and 6.10% p.a. for owner-occupiers and 5.69% to 6.70% p.a. for investors (terms between 2 and 5 years). Variable interest rates range between 4.75% to 4.90% p.a. for owner-occupiers and 5.30% to 5.50% p.a. for investors on interest only repayments. As such, fixed rates don’t look attractive for a couple of reasons.
Firstly, it is very likely that we are at or close to the top of the interest rate cycle. So, there’s limited value in paying a premium (i.e., a higher interest rate) to protect yourself against potentially higher interest rates in the future.
This chart shows that the interest rate yield curve over 5 years is relatively flat i.e., it implies that RBA’s cash rate won’t change much over the next 5 years. Fixed rates may become attractive again when/if the yield curve inverts because it reduces the banks term borrowing costs and allows them to offer more attractive fixed rates. Until that happens, we typically recommend rolling over onto a variable interest rate.
Interest only term expiry
Navigating an interest only term expiry is not always straightforward. Usually, all mortgages have 30-year terms. If you elect to initially repay interest only, your loan term typically consists of a 5-year interest only term plus a 25-year principal and interest term. Contractually, the bank doesn’t have to offer you another interest only term – they can insist that you repay principal and interest for the remainder of the loan term. You have two options; request another interest only term or agree to repaying principal and interest.
There are two common matters you should consider being (1) cash flow and (2) interest rates.
The advantage of repaying interest only is that you minimise your monthly commitment. You might want to do that either because you want to divert cash flow elsewhere such as repaying your (non-tax-deductible) home loan or so that you can take advantage of an offset account, as explained here.
The downside to interest only loans is that they attract higher interest rates. In 2017, the banks began charging higher interest rates for interest only loans to dissuade borrowers from requesting them (at the time the banking regulator was concerned that 40% of new loans were interest only). Interest-only loans attract a higher interest rate of 0.26% p.a. (on average) compared to principal and interest investment loans (or a 0.55% p.a. premium for interest only home loans) – that is the premium you pay during the interest only loan term.
Consider your whole portfolio: some questions to ask yourself
We suggest reviewing your whole mortgage portfolio at one time instead of reviewing loans individually. Doing so ensures that you achieve the best overall outcomes.
When reviewing your loan portfolio, it is wise to consider a few matters such as:
- Will your borrowing capacity change in the future? A change in employment, income or financial situation could either improve or impair your borrowing capacity. These changes might dictate when you make any changes to your loans.
- Do you expect to sell or buy property in the future? If you plan to buy, you need to ensure you have access to equity to fund a deposit and that your lender offers a sufficient borrowing capacity. If you plan to sell, make sure your loan/s are not cross securitised.
- Do you have adequate buffers in place? It’s always good to have loan buffers in case of unexpected changes or unforeseen expenses (e.g., property repairs).
- Does the bank need all properties as security? It’s wise to keep your loan to value ratios under 70% to obtain the highest interest rate discounts. But there’s no point giving the bank anymore security than it needs.
- Would you like to access equity? Some investors like to have access to as much equity in property, even if they have no plans on using the funds. I’m one of those investors. You never know when a good investment opportunity might arise – it doesn’t cost anything to have access.
- Can you consolidate loan accounts and/or clean up your structure? If you have multiple loans that relate to the one property or investment, you should consider consolidating them (if it doesn’t require cross securing your loans). Also, its cleaner to have your loans secured by the property they relate to (if equity allows). These options are typically available to investors that have held their properties for a while.
- Is your current lender under-valuing your property? Different lenders will use different valuers, and valuations can vary significantly. So, if you are short on equity, consider getting another valuation.
- Does your lender/s policies still suit your circumstances? If your situation has changed a lot since you began using your existing lender/s, it is possible that their credit policies and products don’t suit you anymore. Dealing with the wrong lender is frustrating – it’s akin to trying to put a square peg in a round hole.
- Would you like to help your children in the future? If you would like to offer your kids a family guarantee to help them get into the property market, then it’s important that you use a lender that not only provides these but is easy to deal with in this regard.
When to start considering your options
Typically, we would advise clients to engage us 2 to 3 months prior to any fixed rate or interest only term expires. This usually provides enough time for us to research their options and leave enough time to complete a refinance to a new lender should that be necessary.
Of course, if you expect your borrowing capacity or circumstance to change, you might need to begin sooner.
Typical steps involved
Different client circumstances and lenders may dictate different approaches but typically we follow these steps:
- Research your options. If your fixed rate is expiring, then you must ensure the variable rate that will eventually apply to your loan is competitive. The interest rate discount will be recorded in your loan documents, but it’s likely that it will be out of date i.e., discounts have increased a lot lately. Your mortgage broker will need to research your best options.
If your interest only term is expiring, you broker will need to investigate whether your lender will permit another interest only term and if so, what the process is to obtain one. Most banks allow a maximum of two interest only terms – you need to switch to a new lender to obtain additional interest only terms. Some banks require you to go through the whole application process again and others dedicated call centres that clients must call. It is possible, due to credit policies, that a lender may not permit another interest only term. In that case, you will need to refinance to a new lender.
- Speak to your lender. Once your broker has completed all that research, they should speak to your existing lender and request that they match the highest competitor bank discount. Most banks allow brokers to apply for higher discounts via online platforms, so it is usually a quick process, although it might take a day or so for the lender to respond.
- Submit a discharge authority. If your lender refuses to play ball and match a better offer, you may need to refinance (assuming the saving is material of course). Before you do that, we recommend getting your broker to send a discharge authority to your existing lender. A discharge authority is a form used to request a refinance. Sometimes banks won’t offer a better deal until they receive a discharge authority, as they know you’re serious about refinancing. If you don’t receive a better offer within 2 to 3 weeks of submitting the discharge authority, it confirms that your lender definitely won’t come to the party.
- Begin the refinance. If you must switch to a new lender to obtain a fresh interest only term or lower interest rate, so be it. Whilst it can be a bit of a process, in the scheme of things you will be well rewarded for the effort.
It’s a highly competitive market!
The banks understand that lots of borrowers will be reviewing their mortgages this year. As such, they are offering all-time high interest rate discounts to retain existing customers and/or attract new ones. Some lenders also offer cash payments (up to $5,000) too. If you don’t have a proactive mortgage broker, you are most welcome to speak to our team.
