Interest Rate is on the rise

This week we heard the reserve bank governor commented that the Australian Cash Rate is between 15 to 100 basis points below average. With standard variable rates now in the mid 6%, another 1% will mean that those of us who have variable rate loan/s will see an increase of repayments when the rate rises.

One way of controlling this uncertainty is to fix your rate. Before you do so, have a read of an article I wrote some time back on Switching Home Loans and speak to your bank or mortgage broker. If you do not have a broker, go to My Home Loans Broker and register and a broker will be in touch.

An increase in interest rate on a variable rate loan will definitely increase the repayments. Remember when the Reserve Bank increase interest rate, lenders / banks could raise rates independently like that of Westpac Bank. In an example, for an interest only loan, a rate rise of 25 basis points equates to an interest increase of $20.83 per month for every $100,000 of debt, or an interest increase of $250 per year. An increase of 100 basis points will equate to $1000 per year for every $100,000 of debt or $83.33 per month.

So when you think of is, a small rise of 25 basis points might not seem to be a large increase on your mortgage repayments, however when you factor the loan size and potential increase in the future, this amount may increase to a level where it is unserviceable by borrowers. What should borrows do now?

Well there are a few strategies that borrowers can follow;

Budget
A budget is a useful tool. See my article on Budgeting. A budget will assist us in determining what income or money we are receiving periodically and what are our expenses. Remember the GOLDEN rule, money in must be greater than money out.

Money In - Money Out = Positive Savings.
Money Out - Money In = Negative Savings.

Do not fall in the trap that I can spend today as I will be paid tomorrow. There will be other needs and wants that will arise tomorrow and should you spend today and not after you have been paid, you might fall into the "credit" trap.

Re-finance
If you are paying a high interest rate right now. Speak to your banker or broker for options of getting a lower interest rate. Some ways of getting a cheaper loan;

1. Do you qualify for a Package where the bank will provide you with a discounted interest rate. Be careful as you will need to do the numbers to make sure that the annual package fees does not exceed the interest rate benefit.
2. Did you take out a loan in the past with defaults or unstable income and therefore had to pay a higher rate for the loan. If so, and your situation has improved over time, you may be able to re-finance your loan with a standard loan which may have lower interest rates.
3. Are you on a Low Doc loan? If you are able to now show servicing, then moving to a standard loan could lower your interest rates.
4. Do you have facilities that you do not need like Line of Credit? Some lenders will charge for this benefit in the form of a higher interest rate. Some lenders provides FREE redraw or Offset facilities that works in a similar manner. I would encourage you to speak to your banker or broker.

Debt Consolidation
Another strategy is to consolidate your debts. Try and get rid of all high interest loans like car loans, credit cards, personal loans, and store cards.

Some credit card companies are offering lower interest for a set period or for the life of the transferred debt. Remember that set period means that at the end of that period, the interest rate will revert to standard rates. The key to this strategy is NOT to use the card for NEW purchasers or cash advancement as the fine print will state that the low interest is only applicable to the transferred debt and not any new debts.

Borrowers who has equity in their property could re-finance to consolidate debts. Since you are paying the higher repayments already, make sure that you continue to maintain the repayments, this will ensure that your debts will be reduced quicker. The trap here is that, there is more disposable income and therefore I could spend it. Consolidating to a home loan will in effect allow the borrower to extend the debt over 30 years. 

Debt Reduction
Some borrowers have investments in shares and cash. These funds could be used to make a lump sum deposit on to the debt. By doing so, this will reduce the loan amount and the borrower could make a request to their bank to have the repayment adjusted to a more affordable level.

Again, if the repayment at the higher amount is comfortable for the borrowers, I would encourage borrowers to repay more.

NOTE: some borrowers may have tax advantages within their structure. These borrowers should seek financial advice from their accountant or their financial planner before restructuring their finances.

Obtain a second Job
A second job could provide further income and in turn allow the borrower to repay more or maintain their current loan repayments due to a potential interest rate rise.

Cross Collateralised Properties

I have been asked recently, what does it mean to have your properties to be cross collateralised? This term is not a new term. I will try and explain it in the most simplest way possible.

In this article, I am only talking about Cross Collateralising Properties. In general terms so long as there is a tangible value to an asset, like properties, and established businesses, lenders may allow these assets (case by case basis) to be Cross Collateralised.

Cross Collateralised can only occur if you have 2 more more properties. Cross Collateralised Properties in general terms is linking properties into ONE mortgage document. There are benefits in cross collateralising your properties, they are:

Utilising equity in your existing property to secure another property.

This strategy in effect creates a 100% borrowing capacity so long as you have sufficient equity in your existing property to do so. Please speak to your financial planner or tax accountant to understand further in regards to your tax position in utilising this strategy. In this example, it will be assumed that the borrower has the capacity to service the debt and therefore servicing will not be cover in this article. The example starts with a borrower who currently owns a property say with a Market Value of $800,000. Current debt on the property is approximately $500,000. This equates to a 62.50% LVR and $160,000 in equity (80% LVR - $800,000 x 80% -$500,000). So long as you can service the debts, you should be able to borrow up to 80% LVR without the need to pay mortgage insurance.

With this equity, the borrower can now purchase a property up to the value of $800,000 without paying mortgage insurance. To work this out, long form,

Property 1                                                                       $   800,000
Property 2                                                                       $   800,000
Total properties                                                             $1,600,000

Max LVR                                                                                   80%
Max borrowing on properties based on 80% LVR            $1,280,000
Equity not borrowed                                                         $   320,000
Total                                                                                $1,600,000

NOTE: other soft costs are not cover here and it is assumed that the borrower has funds to cover them.

As mentioned before one of the main reasons for doing this is to "tap" equity in your existing property and using this same equity to purchase another property at 100%.

Crossing Properties not belong to different borrowers

Another common reason for Cross Collateralised Properties is when the borrowers were to enter into a borrowing relationship with properties in their respective names. For example, borrower A has a $600,000 property with debts of $300,000, which means, that the current LVR is 50% with $180,000 equity (80% LVR - $600,000 x 80% - $300,000) and borrower B has a $500,000 property with debts of $350,000, current LVR is 70% with $50,000 equity(80% LVR - $500,000 x 80% - $350,000).

If both borrowers wanted to borrower an additional $225,000, borrower A might be able to by paying mortgage insurance however borrower B will not be able to as it will be a negative equity. (NOTE: this does not take into consideration of servicing or the ability to provide commercial facilities). Thus by Cross Collateralising both of their properties, their combined borrowings and also the new debt will fall under 80% LVR and therefore they will not have to pay for mortgage insurance.

NOTE: in this example, it is assumed that the lender is the same for both borrowers. This will not work if the lender are from 2 different lenders.



Selling a Cross Collateralised Property

We have talked about a couple of benefits, here is one main reason why having properties Cross Collateralised may cause problems. Whatever the reason is, there will be a time when one might want to sell their property. If this property is Cross Collateralised, the lender will need to ensure that their exposure to the existing debts can be sufficiently covered by the existing security (property) that is not going to be discharged. If this debt cannot be comfortably covered by the remaining property then the bank may not allow the property to be sold until the debt is paid down to a comfortable level which the lender will be happy to release the property.