Many home owners will have enjoyed the historic low interest rates over 2021 and into 2022 where they got as low as 2.19% for a while there.
Well that probably seems a distant memory now, as you face the prospect of rolling off those wonderful rates onto something more despairing in the 6%+ space. This, together with the other increasing cost of living pressures, is somewhat daunting and to be frank, quite stressful for most.
Chances are, when you undertook your original home loan application, you were assessed by the bank at a stress-tested interest rate of 6-7%. And that together with other sensitivities applied by banks means that there is some buffer built into what you can afford, on paper. But without any income increases, that buffer is diminishing each week with inflationary pressures.
So what options do I have to improve my overall cash flow? It’s quite simple really – either:
- Earn more income;
- Spend less on day to day items; or
- Minimise my home loan repayments
You’re probably already doing your best to improve #1 and #2 above, so I’ll focus on #3…
Let’s start with an example:
If you had an $800,000 loan fixed for 2 years at 2.50%, your loan principal & interest repayments would have been approx. $3,150 per month. You would have also paid off approx. $40,000 from your loan balance in the last 2 years. If you now need to re-fix your $760,000 home loan for 1 year at 6.50%, your principal & interest repayments will increase to approx. $4,920 per month, which represents an increase of $1,770 per month.
When your interest rate was 2.50%, the principal component of your repayment was approx. $1,500, just under half of the $3,150 total payment. With interest rates at 6.50%, the principal component reduces to just $800, approx. 20% of the new $4,920 total repayment. You’ll agree this is a significant (annoying) change. However, you are still reducing your loan balance each period which is a good thing over the long term.
But for some, reducing the loan balance is not top priority at the moment – it’s more important to just make ends meet while things are currently tough, and back yourself to be in a better cash flow position in 1-3 years time. They also don’t want to sell their house which causes disruption to the family and could result in crystalising an on-paper loss of equity – again the preference is to hold on as much as possible with a view that property prices will hopefully improve over the next 1-3 years. Most also would prefer to avoid going back to renting where you don’t have that long term security or a foot in the property market.
So here are some options to consider if you feel like you need (or anticipate needing) cash flow assistance:
- Request interest only: As per the example above, this will reduce some of the increased repayment amount and even $800 per month could be helpful. Most lenders are prepared for these types of requests and I’m finding they are generally accommodating, at least in the short term.
- Consider refinancing to another lender – at the moment all the main banks are offering 1% of the loan amount as a cash incentive for new customers. If your loan balance is $800,000, that’s $8,000 you could use towards upcoming loan repayments. Note you might also have refinancing costs such as solicitor fees.
- Same as #2 above (refinance to another lender) but also simultaneously request interest only. There are lenders who will generally approve interest only without too many questions asked. So in this scenario, you get both the cash back benefit and the interest only benefit.
- Request to extend your loan term (for example back to 30 years) – this will reduce your overall loan repayments while still making sum principal reductions. The benefit of this depends on your current loan term – if your loan term is say 15 years, it will make a reasonable difference. If already at 28 years, then the change will be very little.
It’s important to note that any request for interest only will likely result in higher loan repayments at the end of the interest only period, all things equal.
If you’re feeling the pinch, talk to a mortgage adviser (me) about what options you might have to help navigate through the challenges of the next year and beyond. You are not alone, we advisers and the banks are here to help so don’t be afraid to ask.
Grant Stephens
Mortgage Adviser
Personalised Mortgages
