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Homeowners: Are you ready for 7% interest rates?

Australia’s property investors and homeowners could face higher interest rates from the RBA, in time.

Homeowners: Are you ready for 7% interest rates?

According to some recent indications from Australia’s central bank (the RBA), the organisation which sets interest rates for banks and in turn property owners, the economic outlook is picking up.

The Australian dollar got a boost from the news. Which is great for Australia’s banks, like Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC), which source a chunk of their money from overseas debt markets.

The good news for homeowners is that the RBA appears unlikely to raise interest rates for some time. Meaning, your current record-low interest rates might be here to stay for a little while longer.

However, the bad news is that the RBA suggested the neutral rate for official interest rates is 3.5%. The ‘neutral’ interest rate is the interest rate that is ‘just right’ for the economy and the ideal level for a central bank.  

You: 3.5% interest rates are good!

Me: That is the official interest rate target — the rate you pay on your mortgage would be much higher.

Put it this way, the current official interest rate is 1.5% yet Commbank’s “Standard Variable Rate” is 5.36%.

Imagine if the official interest rate rose 2%.

Would the bank cop that or pass it along to you?

It is perhaps a little simplistic, but the interest rate on a “standard” mortgage could go from 5.36% to 7.36%.

In other words: a 37% increase in yearly interest.

In other (other) words: the monthly repayments on a $400,000 25-year mortgage would go from $2,423 to $2,920.

Plus, the amount of interest you pay over the life of the loan would increase from around $326,000 to $475,000.

Ouch.

Focus on the good news

While that all sounds terrible, it’s not.

The point I’m trying to make is that you should be prepared for interest rates increases.

But remember, even if interest rates rise in the next two years, they will be very gradual.

And to be honest, I’m not entirely sure we’ll get to that level anytime soon.

My advice:

  • Don’t lock in an interest rate yet – if you do, you may be stuck with your lender and forced to pay break fees. According to the Factsheet for Commbank’s ‘Fixed Rate’ mortgage: “An Administrative Fee and Early Repayment Adjustment (ERA) may be payable if you switch during the fixed rate period, (this could cost you many thousands of dollars)”
  • Leave the big banks – mortgages, bank accounts and all. At the very least call them and say you are switching to XYZ Bank – if they want to keep you, they’ll offer a lower interest rate
  • Consider other providers, who are offering comparison rates less than 4%, with offsets and redraws included

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. You can follow him on Twitter @OwenRask.

We Fools may not all hold the same opinions, but we all believe that considering a makes us better investors. The Motley Fool has a . This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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