As a property owner, if you have a loan, you have heard about interest and cash rates. But do you understand what they are and how they affect your mortgage? As mortgage brokers, we see a lot of confusion and misunderstandings around this topic. However, your home loan is likely one of your largest, if not your largest, debt. So, it is important to understand how interest and cash rates work and how they impact your loan.
Let’s start at the beginning
What are interest rates? An interest rate is the percentage of the loan amount a lender charges as interest on a mortgage. Simply put, if you take out a $100,000 mortgage with an interest rate of 3%, you will have to pay $3,000 in interest each year. Interest rates can be fixed or variable and can be influenced by various factors, including inflation, economic growth, and central bank policies, which brings us to the cash rate.
Cash rate explained
The cash rate, also known as the official interest rate, is the interest rate set by a country’s central bank. In Australia, this is the Reserve Bank of Australia. The cash rate controls the supply of money in the economy and influences economic growth and inflation. When the cash rate goes up, banks will generally increase their interest rates, too, because they need to borrow money from the central bank at a higher cost. As a result, borrowers like you will have to pay more in interest on their mortgages and other loans.
What goes up doesn’t always come down
So, why does the cash rate go up? There are several reasons, but generally, it’s because the economy is growing too fast and inflation is getting too high. By raising interest rates, the central bank hopes to slow down borrowing and spending, which can help control inflation. Conversely, when the economy is in a downturn or recession, the central bank may lower interest rates to encourage borrowing and stimulate economic growth.
It’s worth noting that not all lenders follow the cash rate exactly – some might increase their interest rates by a smaller or larger amount, or they might not change their rates at all.
While it may seem logical to expect that when the cash rate decreases, the interest rate on your mortgage should decrease at the same rate, but this is rarely the case. Lenders are businesses, and they factor into their rates a range of risks associated with lending. If the economic environment is perceived as risky, they may decide to maintain or increase their interest rates to mitigate potential losses.
Loan terms and interest rates on offer can vary quite a lot, which is why it is recommended that you shop around and compare loan options to make sure you’re getting a competitive option for your circumstances.
Assessing risk and repayment capacity
If interest rates rise, your loan repayments could increase significantly. This could strain your budget, especially if you’re already committed to other financial obligations. When assessing your borrowing capacity, lenders will typically consider your ability to meet repayments if interest rates rise. You should also calculate your repayments at a higher interest rate to ensure you feel comfortable managing your repayments if rates increase.
Understanding this aspect of financial management aids in safeguarding against economic uncertainty, regardless of market fluctuations or changes in the interest rate.
Broaden your search: beyond interest rates
While interest rates are key in choosing a suitable loan option, they may not be your only consideration. It’s crucial to shop around and consider various mortgage options available in the market. Different lenders offer different types of loans, each with unique features, benefits, and potential drawbacks.
These features may include an offset account, redraw facilities, or the ability to make additional repayments, which can significantly impact how much you ultimately pay over your mortgage.
Additionally, non-interest rate-related fees and charges, such as application fees, annual fees, and early exit fees, can add up to a significant sum. So, while a low interest rate is naturally appealing and very important, looking at the bigger picture helps you find a solution suited to your unique circumstances.
By considering all aspects of a mortgage, you can make an informed decision that suits your needs and long-term financial goals.
The importance of understanding interest rates
As a property owner, it’s important to keep an eye on interest rates and the cash rate, because they can greatly impact your mortgage repayments and overall financial situation. For example, if you’re on a variable-rate mortgage, your repayments could increase significantly if the cash rate goes up. On the other hand, if you see that interest rates are low, it could be a good time to consider refinancing your mortgage and fixing your rate.
Understanding interest rates and the cash rate is crucial for anyone who owns property or is looking to take out a mortgage. By familiarising yourself with these concepts and keeping up to date with economic news and trends, you can make informed decisions about your finances and take advantage of favourable market conditions.
As a mortgage broker, we are always happy to help you navigate these complex issues and find competitive loan options. If you have any questions or want to discuss your mortgage options, don’t hesitate to get in touch.
Terms are subject to approved persons only. This information is true and correct as of 30/05/2023. All of the content above is general in nature and may not suit your personal needs, situation objective & goals.