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What happens when interest rates rise?

What happens when interest rates rise?

With interest rates on the rise, Australians may be wondering how further cash rate hikes could impact their finances?

Interest rates on financial products are influenced by several factors, with one of the most significant being the Reserve Bank of Australia’s cash rate. If the cash rate is lifted, then interest rates may also rise on home loans, savings accounts, and term deposits.

This is because banks and lenders will use the cash rate as a benchmark rate of the interest they should charge on financial products.

When interest rates increase, this can affect your personal finances in several ways, depending on the financial products you have.

How rising interest rates impact home loans

Your home loan is arguably the biggest debt you’ll have, and the interest charged on your repayments can have a significant impact on your household budget. Put simply, if interest rates rise, your home loan repayments will rise too.

If you have a variable rate home loan, you may see your interest rate rise almost immediately if your lender passes on the hike to you. Although it could choose to pass on a smaller hike, or no hike at all, this is unlikely as lenders earn a profit from your interest payments.

For example, if interest rates hiked 25 basis points, a borrower on a 25-year, $500,000 home loan currently paying 3% would see their monthly repayments increase by $52, or $624 in a year.

Impact of a 25 basis point increase on different home loan sizes

Loan sizePrevious monthly repayments

(3% interest rate)

New monthly repayments

(3.25% interest rate)

Increase
$400,000$1,897$1,949$52
$500,000$2,371$2,437$66
$750,000$3,557$3,655$98
$1,000,000$4,742$4,873$131

Source: RateCity.com.au. Based on 25-year home loan term comparing interest rates of 3% and 3.25%. Does not factor in fees or rate fluctuations.

If you have a fixed rate home loan, your home loan interest should remain unchanged for the duration of the fixed period. This is one of the main advantages of choosing a fixed rate mortgage. Once this fixed period ends, however, you may find that your interest rate reverts to a higher variable rate.

How rising interest rates impact savings and term deposits

It’s not all bad news if interest rates hike, as your savings account provider may lift the interest rate on your savings account. Savers typically come out on top when interest rates rise, as the return you gain from your nest egg may be higher.

For those with term deposits, rising interest rates may not impact you until after your term has ended as term deposits lock in your interest rate for a fixed period. If you choose to roll your nest egg into another term however, you may find that interest rates have risen and your return could be greater.

How rising interest rates impact personal loans

If interest rates were to rise and you had a personal loan or car loan with a variable interest rate, you may see your repayments rise if your lender chooses to pass on a rate hike. This could impact your budget and financial situation if you are not prepared for higher repayments.

If you have a fixed rate, your interest rate should remain unchanged until this fixed period comes to an end. However, as personal loans and car loans have much shorter loan terms than a home loan, you may repay your entire debt by the end of your fixed period and never experience the financial impact of rising interest rates.

Do rising interest rates impact credit cards?

Generally speaking, no. Rising interest rates do not typically impact credit card interest rates as card issuers do not follow the cash rate when determining the interest rates on their products.

The average credit card rate has sat around 16% for a very long time, which is not reflective of the fluctuations of the cash rate over the last few decades. There have been instances of credit card issuers linking specific cards to the cash rate, but this is not the standard.

If you have a credit card and feel the interest rate is too high, consider ensuring your pay off your balance in full each statement period to avoid any interest charges. Alternatively, consider switching to a low-rate credit card option that better suits your needs.

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This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.

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