How homeowners can soften fall from brutal ‘fixed-rate cliff’

Recent home buyers have been told to prepare for a financial shock in the months ahead as many come off COVID-sweetened fixed-rate home loans and are faced with as much as a 50 per cent hike in their monthly mortgage repayments.

Since the beginning of the pandemic, more than $380 billion in home loans have been refinanced, peaking in August last year when multi-year fixed rates were at record lows of about 2 per cent, cementing bargain-basement monthly repayments for many homeowners.

The Reserve Bank of Australia has raised interest rates to 1.35 per cent.Credit:

However, since then, official interest rates have risen rapidly from 0.1 per cent to 1.35 per cent, as the Reserve Bank of Australia attempts to dampen runaway inflation. The major banks now expect the cash rate to be between 2.6 per cent and 3.25 per cent by November.

This means the era of 2 per cent fixed-rate home loans is long gone. Homeowners looking to refinance onto a fixed rate in the months ahead can expect a hefty increase in their monthly repayments, dubbed a “fixed-rate cliff” by some market watchers.

For example, a homeowner with a $750,000 loan who fixed it for two years in December 2020 at a 2.08 per cent interest rate is likely to be hit with an average revert rate of 6.68 per cent in December this year, upping their monthly repayments by $1784, or 56 per cent.

Even those looking to refinance on the fixed rates currently available would be lucky to find a rate lower than 4.5 per cent.

Variable rates are substantially lower – about 2.7 per cent at some lenders – but will likely rise in lockstep with official rates to be near 5 per cent by the end of the year.

This places refinancers between a rock and a hard place: do you bite the bullet and fix at a higher rate, or try to save some cash now by opting for a temporarily lower variable rate?

According to Graham Cooke, home loan expert at Finder, a bit of both might be the best option.

“It’s a good idea to split your home loan into two components,” he says. “First is a variable component, in which you have a mortgage offset account to offset the interest you pay.”

“Then for the main component of your loan, find the lowest fixed rate you can and go for that. This is a good way to reduce the interest you pay and protect yourself from future rate increases.”

First home owners are some of the most concerned about rising interest rates.Credit:Peter Rae

However, for homeowners who do not have significant savings to pour into an offset account, Cooke says it might make more sense to fix the entire loan, so there is certainty over repayments as rates rise.

According to Finder, first homeowners are likely to be some of the most affected by rate rises, as they are typically younger with less stable incomes. A recent survey by the company revealed more than two-thirds of first homeowners are worried about meeting their mortgage repayments once rates rise.

Another perk that can take some pressure off the shock of higher mortgage payments is the numerous, and often generous, cashback deals being offered by lenders. Data from RateCity shows some lenders are offering as much as a $5000 cash bonus for refinancing, which can help build a savings buffer against higher payments.

However, these deals sometimes look better on paper than in practice, RateCity research director Sally Tindall says. “Before jumping onto a cashback deal, do the maths to make certain you’re actually getting a good deal once you factor in the rate, fees and switch costs,” she says.

“A couple of grand in cash might sound like a dream come true but if you’re paying a higher rate for the privilege, you could find you’re behind within a year or two, potentially even faster if you have a large loan.”

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