Is this the end of rate cuts? What the RBA is doing instead

Is this the end of rate cuts? What the RBA is doing instead

At today’s meeting, the Reserve Bank of Australia (RBA) kept the nation’s cash rate on hold at 0.25 per cent. This follows one rate cut at the start of March 2020, and a second out-of-cycle emergency rate cut in March 2020.

With the RBA planning to keep the cash rate on hold at this record low for the foreseeable future, it has turned to other measures to keep the Australian economy’s wheels turning while the nation grapples with the coronavirus pandemic.

What happened

Regarding the decision to keep the cash rate on hold, the RBA governor, Dr Philip Lowe, had this to say: 

"The Board is committed to doing what it can to support jobs, incomes and businesses as Australia deals with the coronavirus. The comprehensive policy package announced last month will also support the expected recovery. The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band."

What does the cash rate mean for interest rates?

Australia’s cash rate is one of many factors that banks and other authorised deposit-taking institutions (ADIs) use to set the interest rates on loans and deposits. Cuts to the cash rate often lead to lower interest rates, meaning borrowers pay less while depositors earn less. And when the cash rate increases, higher interest rates can make loans cost more and deposited savings earn more interest.

According to the RBA, there are no plans (for now) to cut the national cash rate to zero, or to move into negative interest rates as seen elsewhere around the world. A negative interest rate environment could lead to unusual situations where depositors pay money to the banks holding their savings, while borrowers could actually earn money on their loans.

With the RBA governor stating that the cash rate won’t increase until Australia hits employment and inflation targets, the current low interest rate environment for both loans and deposits may be the new normal, for the time being. Other economic factors could affect your interest rates, but the cash rate is unlikely to be one of them.

What is RBA is doing instead of rate cuts? 

Australia’s economy is potentially rolling towards recession due to a combination of economic factors, plus the coronavirus pandemic. This means the RBA has taken some alternative steps to help stimulate Australia’s economy. By allowing banks and the government to access money as cheaply as possible, the RBA can encourage them to keep providing support and relief to the Australian people.

A target yield of 0.25 per cent on 3-year Australian Government Bonds

This strategy involves the RBA purchasing three-year bonds in the secondary market (not directly from the government) to help reduce their average yield from around 0.45 per cent to 0.25 per cent.

While this may sound like Quantitative Easing or “printing money”, the RBA has stated that its goal is to provide support for low funding costs across the entire economy, rather than setting certain quantity targets.

Following today’s meeting, it was announced that that the RBA had reached its yield target, and that it would “do what is necessary” to achieve the 3-year yield target, which is expected to remain in place until progress is being made towards the goals for full employment and inflation. 

What does this mean for you?

The national cash rate is just one benchmark used by banks and other ADIs to set their interest rates – the yield on government bonds is another. By buying up these bonds to lower these yields, the RBA may be able to help banks to in turn lower the interest rates on other debt securities, including business loans and home loans.

“By lowering this important benchmark interest rate, we will add to the downward pressure on borrowing costs for financial institutions, households and businesses. We are prepared to transact in whatever quantities are necessary to achieve this objective.”

A term funding facility for the banking system with support for business credit, especially to small and medium-sized businesses

This facility that the RBA has set up allows banks and ADIs to borrow money from the RBA for three years, at a fixed interest rate of 0.25 per cent, which is “substantially below lenders' current funding costs.”

Banks and ADIs will be able to borrow an amount equivalent to 3 per cent of their existing outstanding credit to Australian businesses and households from the RBA. They can then borrow additional funds from the Reserve Bank if they provide large, medium and small businesses with extra access to credit this year. For every extra dollar lent to large business, lenders will have access to an additional dollar of funding from the RBA, and for every extra dollar of loans to small and medium-sized businesses, they will have access to an additional five dollars.

Following today’s RBA meeting, the first drawing are understood have been made from the term funding facility.

What does this mean for you?

The goal of this scheme is to help provide an incentive for lenders to support credit to businesses, especially small and medium-sized businesses. This can help keep small business owners and employees of small and larger businesses from losing their jobs and ending up in financial stress.

“Many small businesses are going to find the coming months very difficult as their sales dry up and they support their staff. Assisting small businesses through this period will help us make that bridge to the other side when the recovery takes place. If Australia has lost lots of otherwise viable businesses through this period, making that recovery will be harder and we will all pay the price for that. So, it is important that we address this.”

While the RBA may not touch the cash rate any time soon, it is instead providing different types of economic support to the government and banks. These, in turn, should be able to more easily provide support and relief to businesses and everyday Australians.

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Learn more about home loans

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 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 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.

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 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.

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 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.

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.

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.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.