Q. Every month I hear about the RBA and the cash rate, but I don’t really understand what it all means. Can you explain what it is, and how you think it will impact me over the coming 6-12 months?
A. The RBA is the Reserve Bank of Australia, Australia’s central bank which is broadly responsible for issuing our currency and ensuring financial stability for our nation.
It’s also responsible for setting our official cash rate, which is the interest rate that banks then pay or charge to borrow money. The cash rate can be increased or decreased by a number of ‘basis points’, so if the rate is 2% and its cut by 25 basis points, the cash rate will reduce to 1.75%.
Rising or cutting the official cash rate is generally led by the economy, and whether it needs boosting through a cut, or slowing through a rise. Because interest rates are essentially the cost of money, a lower interest rate will make borrowing money cheaper for consumers, but it’s also likely to reduce the amount paid on savings. The opposite typically applies for rate rises.
This affects you because banks and lending institutions adjust the interest rates they either charge you for personal loans, home loans, credit cards etc, or pay you for your savings. However, it’s important to note that they don’t have to pass on any cuts or increases; it’s at their discretion though in today’s competitive mortgage market most lenders do pass on both cuts and increases as they must remain competitive.
Lenders can also make out of cycle rate increases or decreases, which we have just seen in October with many banks putting up their variable home loan interest rates.
If you’re wondering why your home loan isn’t a 2% interest rate to match the current Australian cash rate, financial institutions need to make money. They do this by charging a margin on the cash rate, so you may be charged 5% instead of 2%.
If your mortgage is set at a fixed rate, you won’t receive any rate cuts from your lender during the fixed term. Likewise though, you’re protected from rate rises for the same term.
The best course of action that anyone can take is to keep on top of mortgage payments, and shop around for the best interest rate possible, with a home loan that has the features and flexibility you need. A mortgage broker can help you work out what loan and lender is right for you.
If you haven’t already, now might be a good time to consider switching at least part of your mortgage to a fixed rate, which will protect you from interest rate rises for the fixed term period.
Do you have a question for John? Leave it in the comments below and check back each Sunday to see if your question has been answered!
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