The Reserve Bank of Australia (RBA) generally meets on the first Tuesday of every month (except January) to decide whether the official cash rate will stay the same or move up or down. This announcement is particularly important for borrowers with a home loan as mortgage rates tend to follow the official cash rate, impacting the size of the mortgage repayments and the total cost of the loan.
What is meant by the official cash rate?
The official cash rate, or the RBA cash rate, is the benchmark interest rate set by the Reserve Bank of Australia. It represents the rate at which financial institutions like banks lend and borrow money from each other. The cash rate is also called the overnight money market rate, as banks usually process these transactions overnight.
Even though the cash rate represents the interest banks and other financial institutions pay on the money they borrow, it’s an important figure for almost everybody who’s part of the Australian economy. The reason is that lenders typically use the interest they pay as a benchmark to determine the interest they charge for loans and other financial products offered to customers, like home loan borrowers.
It’s not wrong to say that the cash rate plays an important role in determining the interest you pay on the money you borrow from a financial institution. Your monthly repayments for a loan could also vary as your interest rate changes in response to the cash rate changes.
Why does the RBA change the cash rate?
The cash rate set by the RBA is a means to manage the country’s economic condition. For instance, a cash rate hike is a measure to control inflation. When the cash rate is low, people feel encouraged to spend money. On the other hand, a higher cash rate is expected to reduce the money in circulation. When the cash rate increases, spending tends to reduce, and more money is kept in savings accounts, which can help control inflation. Therefore, the RBA may increase the cash rate when inflation levels are high to help people maintain their purchasing power.
Apart from inflation, employment levels and economic growth also affect the RBA’s decision to move the cash rate. Lowering the cash rate can encourage spending to boost economic growth and even create more jobs.
Is the official cash rate the same as your mortgage interest rate?
If you’re on a variable rate home loan, any change in the cash rate is likely to impact your repayment size as variable rates are designed to follow the market. On the other hand, fixed rate customers might not be immediately affected by rate changes. However, their interest rate can jump considerably to match the market rate at the end of the fixed rate period.
In general, when the cash rate is on the lower side (as it was in the past few years), you can expect to find home loans that charge you a lower rate. However, when the cash rate increases, your home loan interest rate increases, too.
As mortgage rates generally follow the cash rate, it’s not surprising if you wonder whether your mortgage rate is the same as the official cash rate. However, that’s not the case.
The cash rate is the benchmark rate lenders use to set their interest rates for various financial products. Lenders also need not always pass on the cash rate change to their customers. When they do pass on the change, they may only pass on a percentage of it.
Why should you follow the cash rate predictions?
If you’re a home loan borrower, you might have noticed your interest rate increase exponentially since April last year. The consecutive rate hikes by the RBA have increased the pressure on many Australian households that must cater for larger monthly repayments and rising living costs.
Following the cash rate predictions can give you some idea about the direction in which your mortgage interest rate might move. This could help you plan your finances better, so you don’t risk falling behind on your mortgage even as the interest charged to you increases.
Depending on your financial goals and situation, you may want to pay off your mortgage faster while the rates are still low or fix your rate at the current level. If you’re finding it challenging to keep up with your repayments, you might want to analyse your expenses and check whether you could move to a cheaper home loan. A mortgage broker could help you analyse whether your mortgage is still right for you and whether you can find a better deal to ease the pressure off your budget.
