During the next 12 months interest rates will continue to rise, so now is the time to get your mortgage in order.

Borrowers should prepare themselves for more interest rate rises in 2010. Most economists are predicting that the official cash rate - which went up to 3.75 per cent last week - will rise to 5 per cent and maybe higher during the course of the coming year. It is time to make sure the household finances are in order.

An interest rate analyst for Citigroup, Josh Williamson, says the Reserve Bank's expectation is that Australian economic growth will return to its long-term average growth rate of 3 per cent or more next year and, in such circumstances, the RBA will move rates back to what it considers a "neutral" setting of 5 per cent or more.

Citi is forecasting that the Australian economy will grow 3.3 per cent next year, rising to a growth rate of 3.4 per cent in 2011. It forecasts that the Reserve Bank's official cash rate will be 4.25 per cent by the end of the March quarter next year and is on track to reach 5.5 per cent by the end of the year.

Lenders will match those changes to official cash rates and may increase rates further to recoup some of their higher funding costs, as Westpac did last week.

Rates have gone up 0.75 of a per cent since October. For a borrower with a $250,000 loan that represents an increase in monthly payments of about $120 a month and for a borrower with a $500,000 loan the increase is about $230. If rates go up another 1 per cent, those repayments will increase another $159 and $320 respectively.

According to the latest Reserve Bank statement on monetary policy, households have done a good job in the past year of strengthening their balance sheets. They have used government handouts to reduce debt and increase savings, putting them in a good position to cope with rising interest rates.

The RBA says many households with mortgages have reduced their level of debt by maintaining the level of their repayments when interest rates declined. "The faster pay-down of mortgage debt reduces the risk of borrowers getting into financial difficulty," it says.

The joint head of lending at Centric Lending Services, Sheyne Walsh, says borrowers should be building a buffer by making extra payments on the loan or putting some extra money into a savings account. They can draw on that buffer if things get tight.

Walsh recommends that borrowers calculate the level at which interest rates would start to have an impact on the household budget and then work out a plan for moving from variable to fixed if rates look like getting to that level.

Very few borrowers have chosen fixed-rate home loans in recent months, despite the Reserve Bank's move in October to start increasing the official cash rate from its emergency setting. Borrowers came to the same conclusion as many interest-rate commentators that the gap between fixed and variable rates was so wide that a move to a fixed rate would end up costing more.

Only 2.6 per cent of the home loans written by Mortgage Choice brokers in October were on fixed rates, down from 4.6 per cent in September.

"The majority of Australians are choosing to ride out the rate rises," the corporate affairs manager at Mortgage Choice, Kristy Sheppard, says.

According to the Mortgage Choice data, the most popular type of mortgage is a basic variable rate loan, which made up 45.6 per cent of home loans written by the company's brokers in October. Standard variable loans made up 31.9 per cent of the total, special variable (with introductory rates) made up 14.6 per cent and line of credit 5 per cent.

The preference for basic over standard variable rates is understandable, given the desire to keep mortgage interest costs low and pay off as much principal as possible. But it is a little surprising, given recent research argues that standard variables discounted as part of a home loan package are a better option.

In August Canstar Cannex reported package discounts of between 0.5 per cent and 0.7 of a per cent, combined with savings on monthly transaction fees and annual credit card fees, were a good deal.

The chief executive of Mortgage Choice, Michael Russell, says the home loan market is getting competitive again, after being dominated by the big banks for more than a year.

Lenders that are getting a bigger share of Mortgage Choice settlements are mostly second-tier banks, including St George, Bankwest, Suncorp, ING Direct and AMP Banking. "Those groups have been aggressive around pricing," Russell says.

Mortgage Choice has put some new lenders on its panel this year including Liberty Financial. Russell says Liberty is offering what it calls near-prime loans. "With the tightening of lending criteria, some banks won't lend to people who have a credit file entry for a late power or telco bill payment," he says. "Liberty is calling those borrowers near-prime."

HIGHER REPAYMENTS MONTHLY REPAYMENTS (25 YEAR TERM)
Loan amount     $ 5.75% 6.00%   6.25%   6.50%   6.75%   7.00%   7.25%   7.50%
100,000         629     644     659     675     691     707     723     739
250,000         1573    1611    1649    1688    1727    1766    1807    1847
400,000         2516    2577    2638    2701    2763    2827    2891    2955
500,000         3145    3221    3298    3376    3454    3534    3614    3694
750,000         4718    4832    4947    5064    5181    5300    5421    5542
SOURCE: INFOCHOICE