Opinion: What's all this chat about an RBA cut?

What's all this chat about an RBA cut?

Update 2:30pm, Feb 3: RBA has now cut rates by 0.25%!

You may have been hearing more noise than usual about this month’s Reserve Bank of Australia’s (RBA) meeting. The reason for this is because it appears we are now getting much closer to seeing a rate move by the RBA – something we haven’t seen in almost 18 months. Now that this talk has well and truly escaped the finance section and hit the headlines, the questions on many people’s lips are why is this and what does it mean for me?

Firstly, why does the RBA even move rates?

The RBA cuts rates if it wants to spark up the economy, or increases rates if it wants to calm it down. The idea behind this is if people have cheaper home loans (and other loans) they will spend the extra cash elsewhere, and if they get less interest on their savings account they are more likely to invest it elsewhere. Vice versa for a interest rate rise.

What is the current situation?

The current signs point to a struggling economy, both within Australia and globally. Locally, unemployment is not getting any better. There are a few conflicting data sources for this, but none of it looks too good and this is a general sign of a struggling economy.

There is also what has been dubbed the global “currency war”. Europe is pouring money into their economies to stimulate, Switzerland just stopped putting an artificial limit on their currency, Canada just cut their version of the RBA rate, Denmark is now negative 0.5 percent for their official rate – which has resulted in people paying money to put money in the bank and getting paid to have mortgage!

Closer to home, the Aussie dollar (AUD) has been relatively high for a while, despite recent drops. This makes it hard for our export (expensive for other countries to buy our stuff) and tourism industries (backpackers can’t afford our schooners) to compete, which puts a strain on the economy. The RBA reportedly wants the Australian dollar to sit around 75c US and it’s been heading that way on the back of expectations of an RBA cut. If there is no cut, it will likely bounce back higher, quite quickly. A low RBA rate can force the AUD down as it makes it less attractive for other countries to put their money into anything priced in our money.

BUT! There’s always a but…

A cut may make the investor property market go a little too wild, which is the last thing the already scarce first home buyers need in some states.

There is no doubt that Sydney and Melbourne are already “frothy”. Sydney has just finished two years in a row of double digit growth, more growth would continue to hurt affordability and if something goes up too much, it must come down – despite some parts of Australia somewhat defying this rule, so far.

Meanwhile the rest of the country is a mixed bag. There’s only one RBA rate, so they need to take it all into consideration.

Inflation – how quickly prices on everyday things increase – is another big factor the RBA looks at. In the recent figures this came in higher than expected. If people spend more, prices can increase quicker. If the RBA cuts rates then people may spend more, so RBA cuts can equal more inflation.

But like unemployment, there are a few different ways to measure it. “Untradeables” inflation is low, and this shows the RBA how much things cost that most Aussie’s choose to spend their money on, rather than the exported/imported stuff, like that iron ore you keep hearing about.

So it looks like inflation alone will not stop the RBA cutting rates as what we are spending money on isn’t getting more expensive too quickly. By the way, the RBA defines “too quickly” as anything more than three percent, as they aim to keep in between two percent and three percent.

In between all this RBA banter you may have noticed petrol getting cheaper. Retail petrol prices have fallen 32 percent since last July, which will save householders on average close to over $60 a month, according to a report by Fitch Ratings. For many people that’s a similar, if not larger, savings than would result from a rate cut. So even though a rate cut will help home owners, the fall in petrol prices will have a larger positive impact to everyday Australians. For the RBA, this means some of the job may already be in progress, so maybe they don’t need to cut. 

So will they cut?!

At this point it is too close to call, Sportsbet agrees. That’s right – in true Aussie form, you can punt on the RBA meeting. Despite the speculation and opinions being thrown around, this month it’s not much easier than trying to guess the Melbourne Cup winner in November. It really could go either way.

That’s all well and good, but what does it mean for me?

It might not happen this month, but it is looking very likely that it will soon. This will mean even lower home loan rates, but lower savings rates too. If you’ve got money in the bank, you’ll need to search hard for a decent deal, here’s a good start. If you’ve got a home loan, consider piling that extra money you save each month (if you’re on a variable rate) into the loan – your older and wiser self will thank you one day. Of course, make sure you’re on a good rate too – with around 0.80% difference between the the average variable rate and some of the lowest on the market, there are three free RBA cuts available for anyone who switches to one of the lowest rates.

 

 

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How much of the RBA rate cut do lenders pass on to borrowers?

When the Reserve Bank of Australia cuts its official cash rate, there is no guarantee lenders will then pass that cut on to lenders by way of lower interest rates. 

Sometimes lenders pass on the cut in full, sometimes they partially pass on the cut, sometimes they don’t at all. When they don’t, they often defend the decision by saying they need to balance the needs of their shareholders with the needs of their borrowers. 

As the attached graph shows, more recent cuts have seen less lenders passing on the full RBA interest rate cut; the average lender was more likely to pass on about two-thirds of the 25 basis points cut to its borrowers.  image002

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Variable rate

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Split rates home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

What is the difference between a fixed rate and variable rate?

A variable rate can fluctuate over the life of a loan as determined by your lender. While the rate is broadly reflective of market conditions, including the Reserve Bank’s cash rate, it is by no means the sole determining factor in your bank’s decision-making process.

A fixed rate is one which is set for a period of time, regardless of market fluctuations. Fixed rates can be as short as one year or as long as 15 years however after this time it will revert to a variable rate, unless you negotiate with your bank to enter into another fixed term agreement

Variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts however fixed rates do offer customers a level of security by knowing exactly how much they need to set aside each month.

Does Real Time Ratings' work for people who already have a home loan?

Yes. If you already have a mortgage you can use Real Time RatingsTM to compare your loan against the rest of the market. And if your rate changes, you can come back and check whether your loan is still competitive. If it isn’t, you’ll get the ammunition you need to negotiate a rate cut with your lender, or the resources to help you switch to a better lender.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

What is a standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

What is a honeymoon rate and honeymoon period?

Also known as the ‘introductory rate’ or ‘bait rate’, a honeymoon rate is a special low interest rate applied to loans for an initial period to attract more borrowers. The honeymoon period when this lower rate applies usually varies from six months to one year. The rate can be fixed, capped or variable for the first 12 months of the loan. At the end of the term, the loan reverts to the standard variable rate.

What is a split home loan?

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.