Interest rates to hit 4.25% in 2015

Home owners and property investors may need to take steps to protect themselves, if economists’ predictions about interest rates are correct.

Economists suggest the official RBA cash rate will be at least 1% higher than its current 2.5% level, and may even be as high as 4.25%.

Homeowners and especially property investors should be preparing now to face higher mortgage rates next year. The historical normal level for variable rates is around 7%, which could see borrowers paying up to an additional $300 a month extra on their mortgage. Anecdotal evidence suggests many borrowers have kept up their monthly repayments, despite lower interest rates, which will stand them in good stead.

The problem will be for those who have assumed mortgage interest rates would stay around 5% for many years to come, and are in debt up to the neck. Property investors with a number of properties may think they can cope with higher interest rates, but it’s also important to consider that unemployment is rising, so rental income may fall at the same time.

That’s a double whammy effect of declining income and rising expenses, which could see many investors face the prospect of having to sell into a falling market.

A small number economists are still holding out predictions of a rate cut later this year, including Alan Oster at National Australia Bank (ASX: NAB), Saul Eslake at Bank of America and Tim Toohey at Goldman Sachs. Westpac Banking Corporation’s (ASX: WBC) Bill Evans triggered a rise in the Aussie dollar earlier this week, when he threw out his forecasts for two rate cuts this year.

Macquarie Group (ASX: MQG) also recently revised its expectations from two rate cuts to just one this year. The investment bank thinks the economy is going to struggle due to difficult trading conditions for business, and the Australian dollar which is defying all odds and continues to rise.

The RBA regards the AUD/USD exchange rate of over US 90 cents as ‘uncomfortable’, and may be forced to cut the official cash rate, if it fails to drop back to levels of around US 85 cents.

Foolish takeaway

With some banks and lenders offering three-year fixed rate home loans below 5%, including Commonwealth Bank of Australia (ASX: CBA) with a 4.99% rate for two years, now may well be the time for home-loan borrowers to consider fixing part or all of their loan.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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