If you’re a first home buyer starting your home loan journey, you may have seen discussion about the cash rate and how this can impact interest rates.
It’s safe to assume that over a 20-30 year home loan, your interest rates will fluctuate. But how does this happen, and what does it have to do with the cash rate?
It’s important to understand the distinction between the official cash rate and the interest rate on a home loan, and how one affects the other.
What is the official cash rate?
The Reserve Bank of Australia’s cash rate is not the same thing as a mortgage interest rate, but it can influence the interest rate a lender charges on a home loan product.
The cash rate is the interest rate charged on unsecured overnight loans between banks. You can look at the cash rate as a sort of benchmark interest rate, and if the cash rate is increased or decreased, it’s safe to assume home loan rates will follow suit.
Every first Tuesday of the month (besides January) the Reserve Bank of Australia meets to determine whether the cash rate should go up or down or remain the same, and this impacts millions of Australians.
- If all of this sounds very complicated, just know it simply means Australia’s central bank sets a benchmark rate, and if it moves your home loan, personal loan, savings account, or term deposit rate may move as well.
How does the cash rate impact mortgage rates?
Your home loan lender will look to the RBA’s cash rate as a key influential figure for how it should set its interest rates for home loans.
If the cash rate is on the lower side, as it was for around over a decade between 2010-2022, you may find that home loan rates are lower as well. And if the cash rate is increased, home loan lenders will generally increase interest rates to follow suit.
This change will almost always impact variable rate home loan customers first, and variable rates are designed to fluctuate with the market. Fixed rate home loans will remain locked in at the rate you chose for your fixed period, but once this ends, customers may find their interest rate reverts to a higher variable rate.
Lenders don’t always pass on a cash rate change in full though, nor do they always pass it to variable customers. During 2020 when the cash rate was cut several times in response to the economic impacts of the pandemic, some banks only passed on rate cuts to fixed rate home loans. But as a general rule, lenders should mirror cash rate changes and pass these on to their customers.
Some homeowners may opt for a split rate home loan to get a ‘best of both worlds’ option for their mortgage repayments. By splitting your interest rate repayments between partially fixed, and partially variable, you can ensure that a portion of your repayments remain the same while the others may fluctuate according to market conditions.
- Home loan rates tend to follow the movement of the cash rate
- A cash rate change will impact variable home loans first
- A fixed rate may protect your repayments from rate changes over a fixed period
- Some customers choose a split rate option for the ‘best of both worlds’
Why does the RBA change the cash rate?
The cash rate will move in response to macroeconomic factors, like inflation, wage growth and employment.
Homeowners may remember the days when home loan interest rates were in the teens, with 15% interest not uncommon. This was because the RBA’s cash rate was sitting at a high of 17.5% during the early 1990s recession.
The cash rate hike that occurred in May 2022 was noted as being in response to the higher inflation levels recorded at the start of the year.
A lower cash rate typically stimulates household spending and investment, as borrowing funds becomes cheaper and Australians feel more encouraged to spend. If inflation climbs too high, the RBA may hike the cash rate (as it did in May 2022) to try and keep inflation under control. A higher cash rate means that, in theory, less money will be in circulation and more money will be kept in savings accounts, helping to reduce inflation levels.
If you’re looking to take out a home loan and wondering how you can predict if interest rates will rise or fall, it can be worth keeping up with the news around these macroeconomic factors.
Alternatively, consider getting in touch with a mortgage broker for more personal advice around how the market may fluctuate, and what this means for your home loan application.