Every month the Reserve Bank of Australia (RBA) meets to ponder a decision that has the potential to affect every person with a mortgage in the country – what to do with interest rates.
The outcome of this monthly meeting will decide whether the cash rate goes up, down or remains on hold. And while the rate they determine doesn’t directly correlate with mortgage interest rates offered by the banks, it usually influences the direction that mortgage rates will head in.
Here’s an insight into how cash rates affect mortgages and ultimately the wider property market.
The cash rate
As Australia’s central bank the RBA is responsible for currency, monetary policy and handling inflation. In other words they steer the ship and ensure stability in the Australian financial system.
One of their key responsibilities in this role is to set the official cash rate, and they meet on the first Tuesday of every month to undertake this task.
Basically the cash rate is the rate the RBA offers on overnight loans to commercial banks. Or as the RBA explains, it’s the: “interest rate which banks pay to borrow funds from other banks in the money market on an overnight basis”.
The RBA’s decision is influenced by a wide range of factors including inflation, the performance of the Australian dollar, the housing market, Australia’s gross domestic product (GDP) and levels of consumer confidence.
Changes to the rate have widespread repercussions for the economy as a whole. At a record low
At present Australia’s cash rate is at a record low, and has been since August last year when it dropped to 1.5 per cent.
The RBA has maintained this level in a bid to boost consumer confidence, spur on spending and maintain impetus within the property market.
Ultimately, they are trying to achieve growth within the country that’s not too high but does represent an improved financial future for the nation as a whole. The target is usually between 2-3 per cent, and is reflected in the Consumer Price Index (CPI – based on the cost of a range of common goods and services).
Therefore, if the RBA wants to stimulate the economy it will lower the cash rate, if inflation is rising too quickly and goods and services are becoming too expensive, it will raise the cash rate.
How the cash rate affects mortgages
While the Reserve Bank has set the cash rate at a record low of 1.5 per cent, the interest rates the banks employ for mortgages are at least a few percentage points higher.
At present bank interest rates for mortgages vary from 3.49% to 4.79% depending on the type of loan, term and borrowing conditions.
These mortgage rates reflect the cash rate, with variable loans generally going up or down in line with what the cash rate does.
For example in August last year if you had a home loan with a variable rate of 4.25 per cent, chances are it dropped by .25 per cent in line with the RBA’s announcement they were lowering the cash rate by a quarter of a percentage point.
Banks were not obliged to pass on any or all of this fall, but it is in their interest to do so to maintain their image, keep customers and play their role in the economic fortune of the country.
The cash rate only affects variable home loans. If your home loan is fixed, you have locked in a specific interest rate for a set period of time like two years.
How interest rates affect the property market
Low interest rates allow people to enter or maintain a presence in the housing market more affordably.
For example if you have a 30-year home loan of $400,000 and the interest rate is 4.0% you will make monthly interest repayments of $1333.
If the interest rate increases to 10%, monthly mortgage interest payments will rise to $3333.
It’s important to note interest rates can and do increase substantially. Australia’s highest ever mortgage rates were seen between June 1989 and March 1990 when the “recession we had to have” prompted rates to hit 17%.
For a mortgage of $400,000 that would have equated to monthly interest repayments of $5667.
Australia’s current low interest rate allows buyers to enter the market and maintain their payments readily, and it’s seen a renewed interest in Australian property investment.
In turn this results in rising house prices as more people seek to enjoy the low rates on offer and housing stock becomes short in supply. The opposite is also true – when interest rates rise, the property market tends to enter a decline and more homes are available at a lower price.
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