Why do home loan interest rates rise and fall?

It’s official: interest rates are on the rise in Australia. The Reserve Bank of Australia (RBA) hiked the official cash rate earlier this month for the first time in 11 years, and more rises are expected throughout 2022.

But why have home loan interest rates risen? How are interest rates and the cash rate connected? And how is the cash rate determined in the first place?

In this article, we explain what factors influence home loan interest rates, how interest rates have changed in Australia over time and how the latest rate hike could impact you.

• Related: How to prepare for an interest rate increase
• Related: Tips for securing a low interest rate in 2022
• Related: Interest rates are rising: here's how to save on your mortgage

How are interest rates impacted by the cash rate?

There are a few factors that influence the interest rates lenders pass on to home loan borrowers.

Let’s start with the official cash rate (OCR). The cash rate is the interest rate charged on overnight loans to commercial banks. It is determined by the RBA and is announced on the first Tuesday of every month (except January).

The RBA is the central bank of Australia and their responsibility is to maintain the economic health and prosperity of the country. They promote financial stability, low unemployment rates and a steady inflation rate.

When the RBA works out the cash rate, they consider factors like employment levels, inflation, the housing market, gross domestic product as well as consumer and business confidence.

The cash rate impacts how much financial products cost, which is why lenders take it into account when determining the interest rates they offer on products like home loans and savings accounts.

This means the cash rate influences what interest rate you end up paying on your home loan, but so do the decisions of lenders themselves.

While lenders generally follow the guidance of the cash rate, sometimes the interest rates they offer might differ. They might need to account for higher operating costs, or remain competitive against other lenders.

Why does the cash rate fluctuate and what does this mean for home loans?

The RBA moves the cash rate for two main reasons:

1. To promote economic growth
2. To slow down growth in the economy

When the economy is in need of growth, the RBA tends to lower the cash rate. Indicators of poor economic growth include high unemployment and low wage growth.

Decreasing the cash rate – which lowers interest rates – encourages people to borrow and spend money. This is why the RBA continually dropped the cash rate throughout 2020.

The COVID-19 pandemic meant unemployment levels shot up, so the RBA lowered the cash rate to try and boost economic growth.

On the other hand, the RBA will typically increase the cash rate to slow the economy down. This can happen when inflation is accelerating too quickly.

This is part of why the RBA raised the cash rate at the start of May this year, when we saw inflation rise to 5.1%.

Increasing the cash rate means borrowing money becomes more expensive, which can slow down sectors like the property market and help return the economy to normal.

What do interest rates look like over time in Australia?

For many Australians with a home loan, the cash rate rise in May this year is the first rate hike they’ve experienced since taking out a mortgage.

Prior to May’s cash rate hike, the last time the RBA increased the cash rate was in November 2010. Since then, the rate has either decreased or remained unchanged from month to month.

So, over the last 11 years, interest rates have remained pretty low. Australia was recovering from the 2008 Global Financial Crisis (GFC) and inflation levels were low, meaning the RBA consistently dropped the cash rate to stimulate the economy.

The cash rate hit an all-time low of 0.10% in November 2020, and remained at that rate until May 2022.

The drop in the cash rate was largely due to the COVID-19 pandemic, which caused a recession. This recession meant the economy needed stimulating, and dropping interest rates to encourage spending was one way of doing this.

Now that inflation has risen and unemployment is sitting at a low 3.9%, the RBA has increased the cash rate by 25 basis points to 0.35% to normalise the economy.

More cash rate rises are expected throughout the rest of 2022, however these will likely be incremental.

How will recent rate rises impact you?

If you’re wondering how the latest increase to the cash rate – and the increases that are still to come – will affect you, you’re not alone. Here are some of the ways rate rises could impact you.

1. Your home loan repayments may go up

Some lenders have already started to pass on the cash rate rise in full to their home loan borrowers. This means that interest rates on home loans are rising.

Borrowers with a variable loan will feel the rate hike first, whereas borrowers with a fixed rate won’t experience higher repayments until their fixed term ends.

Although fixed interest rates are rising too, it could be smart to think about fixing your interest rate before further cash rate increases happen.

2. Interest rates might rise on other debts like credit cards and personal loans

If you have debts like credit cards, personal loans or car loans, you may also be hit with an interest rate increase. This means your repayments could start going up.

You might consider debt consolidation, which involves bundling debts like credit card debt or a car loan into your home loan. This creates one single monthly repayment.

Plus, consolidated debt is charged at home loan interest rates, which tend to be lower than interest rates on other debts.

3. You could earn more in interest on savings products

Rising interest rates could boost the amount of interest you earn on your savings.

Interest rate increases don’t just apply to debts like home loans, but assets like savings too.

So, you could get a better return on products like term deposits and savings accounts now that rates have risen.

4. Property prices may fall

Are you an aspiring home buyer? You may find your dream home for less now that interest rates have risen.

Rising rates can help ease growth in house prices. This is because higher interest rates mean borrowers don’t have the capacity to borrow as much as they might have when rates were lower, which can drive property prices down.

Looking for ways to save on your home loan now that rates are going up? Our Home Loan Specialists are here to help. Book an appointment at a time that suits you.

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.