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If you’re new to the home loan or finance world, you may be wondering ‘what is the Reserve bank?’ ‘How do they affect home loans?’ ‘What does a rate increase mean for me?’
Here’s a quick overview of what it is and why it matters.
What is the RBA?
The RBA (Reserve Bank of Australia) has been the nation’s central bank since 1959. As our central bank the RBA’s role is to ensure the stability of our currency, employment and overall economic prosperity. Think of the RBA as the ‘boss’ of Australia’s money and economy, as they’re in control of managing the amount of money circulating around the country, by ‘controlling’ interest rates.
What is the cash rate?
As part of its role, the RBA adjusts something called the ‘cash rate’ in an effort to drive certain changes in our economy. The cash rate is the interest your bank or lender pays to borrow from other banks while carrying out its regular business. The RBA has increased the cash rate in a series of steps since early last year, and it is projected to continue increasing until at least the end of 2023. At 4.10 % this June, it is at its highest point in 11 years.
How do cash rates affect interest rate hikes?
The cash rate is the interest that banks pay on loans from other banks, whereas your home loan interest rate is the price you pay the bank for borrowing money to purchase your new home.
Here’s how the official cash rate has shifted over the last 25 years in Australia.
The two rates are related because when the RBA increases or decreases the cash rate, banks change their interest fees to borrowers. Until recent months the cash rate has been stable and low, and home loan interest rates have benefited. The cash rate started hiking in May 2022 and interest rates have followed.
Why is the RBA increasing the cash rate?
At the moment the RBA is increasing the cash rate in an effort to reduce inflation. Inflation happens when prices increase faster than people’s incomes, and people are increasingly unable to purchase goods and services.
The general idea is that, as interest rates increase, people will need to allocate more of their income to meet loan repayments and other financial commitments. Consumers will therefore have less to spend, which can reduce debt and lower inflation.
How do changes in the cash rate affect home loans?
First of all, the interest a lender charges on a home loan taken out at the moment will be higher than previous years.
The RBA cash rate changes don’t necessarily indicate a change in your loan interest rates but they often do. In general, if the cash rate increases, banks will probably maintain or increase their lending rates to pass the increased cost of doing business on to borrowers.
To date, the major banks have responded by passing the cash rate increases on, with a further 0.25% increase in interest rates this month and more possible. This means thousands of dollars more on the average mortgage repayment each year.
Another concern for those of us looking to enter the property market, is that increases in the cash rate are often linked with a reduction in the maximum loan size a lender is prepared to consider when you apply for a loan.
Lenders will also become more strict when it comes to assessing your ability to meet mortgage repayments.
The Cash Rate increases from from 2022 have been at record levels.
Put simply, as interest rates rise, the maximum amount a lender is willing to lend to a borrower decreases, because mortgage repayments will be higher.
So it’s true to say that, overall, it can be harder to get your hands on or even maintain a home loan during these times. When cash rates change, we often see homeowners looking to refinance as fixed rate periods end or as variable rate changes become harder to manage. This is why homeowners and property investors are watching the RBA changes closely right now.
How are the different home loan types affected?
You will have noticed an increase in discussions around ‘variable’ and ‘fixed’ loans. In a nutshell, these are the two main types of home loan. Each has their advantages and disadvantages in periods of rate change.
- Variable rate home loans change in response to market changes. If your loan is a variable rate interest loan, changes in rates will affect you much more immediately. If RBA cash rates increase, this is generally passed on to you, the borrower, as your bank increases the interest on your home loan. This means your monthly payments will increase. This sounds bad, but people chose variable loans in an effort to take advantage of the fact that when the cash rate lowers again, your bank interest rates should go down, and your repayments decrease.
- A fixed rate home loan has an agreed interest rate for a set period of time before reverting to either a new variable rate or another fixed rate period. Those with fixed home loan rates are protected from increases until their fixed rate period ends, at which point they must renegotiate or ‘refinance’ the agreed interest rate of the loan at the current market value. These types of loans are helpful in times of increase, but do not pass on any decrease in rates as markets change during the fixed term period.
Still worried? Don’t be.
At the moment, all home owners are facing a period of uncertainty. The cash rate has increased significantly since early 2022 and is projected to increase further until at least the end of this year. For the typical owner occupier who pays a variable rate, this is a big deal. Investors with a fixed rate may have been protected from immediate changes for at least the short term, but most will have to refinance soon to avoid “rate shock”.
So what’s the good news? Fortunately, there are signs that inflation has peaked and appears to be falling. There is therefore a projected decrease in the cash rate over 2024, should the local and global situations remain stable. The housing market has been relatively stable so far, with more houses likely to enter the market later this year.
There are many options that might help you progress more quickly with your home loan if you know where to look. With the help of a qualified broker you can still negotiate the steps to find the home loan that’s right for you to get the dream home. Reach out to us today and we’ll put you in touch with an experienced YBR Home Loans mortgage broker near you.
