Deadling With Interest Rates Increases

Interest rates are rising and sharemarkets are falling. The Reserve Bank of Australia has raised interest rates several times in the last year or so, but there may be no immediate end in sight.

Economists are predicting the RBA will impose two more rate rises in 2008, with a total rise of 50 basis points and likely to push variable mortgage rates upward into double digits.

With these prospects to face, home owners have to think of strategies to cope with bigger home mortgage payments affected by the rising mortgage rates. This is particularly important for most people with outstanding home mortgages since their home is their single most valuable asset, the foundation of their wealth.

What Can Home Owners Do?

Fix a Portion of the Mortgage

Changes in interest rates will affect only standard variable rates. In a regimen of rising interest rates, you can protect yourself from future rises by partially fixing a portion of your mortgage. Since there is also the chance that interest rates may decline at some future time, you may wish to keep the fixed rate period to a few years, so that you can renegotiate the fixed interest rate.

Use an Offset Account

You can arrange with your lender for a mortgage offset account, where you can deposit your savings and any extra funds. This can be especially useful if you happen to have excess cash sitting in your savings account every now and then. With a mortgage offset account, the balance you have sitting in the savings account is offset against the balance owing on the mortgage. This helps you save interest.

For example, you may have $150,000 owing on your mortgage and you also have $10,000 deposited in a mortgage offset account. In this situation, the mortgage interest is calculated on $190,000 rather than $200,000.

This option also gives you a tax benefit, because you’re actually saving money on your mortgage payments rather than earning assessable interest on a savings account. Note that when you use this option, you must remember to check the terms, as not all lenders offer 100% offset accounts.

Adjust Your Budget to Reduce Expenses

You can create a new budget to plan expenses more carefully. It will mean reducing your discretionary spending, like buying takeaway food. It is good to establish a target amount of savings, and then see from which spending items you can get it.

For discretionary spending, set and keep within a weekly limit and withdraw cash enough only for a week. Limit credit card use to non-discretionary spending only, such as utility and phone bills.

Match Your Payments

It is best to match your wage payments with your mortgage payments. That is, if you get paid weekly, schedule your mortgage payments weekly. On the other hand, if you get paid monthly, pay off your mortgage monthly. The idea is that you avoid having your money sit in a savings account earning little — but taxable — interest for one or more weeks each month. If you happen to change jobs and your pay period changes, be sure to alter your repayment schedule accordingly.

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