Understanding interest rates

The Reserve Bank of Australia has recently cut the interest rate. So what does this mean and how do interest rates affect the property market

Why interest rates are important

The RBA announced the first cut in 31 months back in 2011, and since then you may have noticed a high level of news coverage about this issue. The RBA’s primary role is to set monetary policy, including setting the cash rate. To do this, the RBA uses economic indicators including the country’s unemployment rate, producer price index, retail sales, and consumer price index. A cut in interest rates is used by the RBA to stimulate growth, because lower interest rates leads to a lower cost of borrowing. When borrowing becomes more affordable, consumers tend to increase their spending, which then in turn stimulates the Australian economy.

Impact on mortgages 

A rise or fall in interest rates is of particular importance to homeowners. When you take out a mortgage, you have the option of selecting a product with a fixed or variable rate. If you opt for a fixed rate mortgage, fluctuations in interest rates won’t affect your loan. However, if you choose a variable rate, the amount you owe could change along with the interest rates. There are pros and cons to each type of mortgage, so it’s important to look at the overall stability of the economy and interest rate trends to determine the best option for your financial situation.

For example, if the economy is slow, it’s likely that the RBA will cut interest rates in a bid to stimulate spending. During these times, homebuyers may choose a variable mortgage which allows them to benefit from these rate reductions. By contrast, if the economy is doing well, it may make more sense to choose a fixed mortgage before the RBA increases interest rates.

International influence 

Although in the past nearly all Australian lenders adjusted their variable mortgage rates to match the RBA changes, this has recently changed. Banks now make their own changes outside of what the RBA does, which is important to note if you opt for a variable loan. In some cases, if the RBA slashes rates by 0.25% this will be mirrored by a bank’s mortgage rate, but not always. Banks are increasingly using a global outlook to determine their rates, as many depend on overseas markets to obtain mortgage funding.

The bottom line

It’s vital to think about interest rates if you’re taking out a home loan. Interest can cost you hundreds of thousands of dollars over the course of a 25-year mortgage, so it’s not something to take lightly. Be sure not only to look at the current state of the economy, but compare all bank loan offers carefully in terms of fees and fine print. A loan’s headline rate may be different from the true cost you pay over time, so use mortgage comparison tools to find the best rates.