Understanding interest rates - Murray Home Loans

On 5 September 2017, the Reserve Bank of Australia (RBA) maintained the current official cash rate at the record low of 1.50%. This was the twelfth meeting in a row that they have held the rate steady. As a consequence, variable home loan interest rates are not expected to change. Further, most banks predict few if any changes to the cash rate in the rest of 2017 and well into 2018.

Without needing a degree in economics to explain or understand the cash rate let me try and break down what this is all about.

What does the RBA do?

The RBA meets on the first Tuesday of each month (except January) to decide on the official cash rate target. When the RBA decides the appropriate cash rate, the primary aim is to keep inflation within its target band of 2-3%. The theory is that when inflation is moderated in this way, it keeps the value of the Australian dollar stable and supports long-term growth in the economy. This is with a view to keeping a high employment rate.

How does the RBA decision affect me and my home loan?

The RBA announcement is watched closely each month by the media and home-owners. This is because it is one of the key factors that determine the interest rates set by banks for their home loans. The interest charged by banks can obviously impact on the household budget and disposable income because of the relative size of their mortgage repayments. The graph in this article shows the clear correlation between the cash rate and variable home loan rates. While banks’ lending rates have historically risen and fallen in line with changes in the RBA’s cash rate announcement, in recent years the banks have been criticised for not following the RBA’s lead closely. At the same time, we can see that the gap has widened due to a combination of greater profit and rising bank costs.

What does it mean interest rates in the future?

The majority of economists are suggesting a period of stability with no changes to the cash rate for the rest of 2017 and possibly much of 2018. Extreme economic or geo-political shocks could change this but for the time being this is the forecast. This should mean stable home loan rates as well.

While the interest rate on variable personal loans can change with the cash rate, they generally don’t for fixed rate home loans. Fixed interest rates are based on current and future interest rate expectations.

A word of note: Banks can alter home loan interest rates at any time. In 2017, we have seen lenders vary them in response to tightening regulatory change. We have also seen them change the rate to suit their demand for certain types of home loans (predominantly to slow down investment loans and interest only loans). As a broker, sometimes we get no notice, sometimes we may get a few days’ warning.

Despite the relatively stable cash rate, we have seen and continue to see a highly competitive landscape for home loans. The major lenders – CBA, ANZ, NAB and Westpac – continue to dominate the market and grab the headlines. But they are certainly not leading the way with the most competitive rates. Many smaller lenders such as ING, Newcastle Permanent, ME Bank, Auswide, Bank Australia, AMP, Heritage, Bank of Queensland are doing that with rates starting near 3.6%. This is one of the reasons why the market share of the majors continues to decline.

What can I do to avoid changes to my interest rate?

Variable home loans are variable by their nature. Fixed interest rates are fixed for a set length of time. So, fixing some or all your home loan is the main way to avoid variations. Fixed rates aren’t for everyone (see Fixed vs. Variable Loans) as they can be less flexible and you miss out on the benefits of any interest rate decreases. Therefore, it is important to think carefully when choosing whether to fix a home loan and how long to fix it for.

What if I have an old home loan?

A home loan taken out today compared to one a few years ago may be the same product but interest rates have become much more competitive. It is not unusual to see 5-year-old home loans at 1% higher than competitive rates. There are two options to achieving a lower interest rate – renegotiate with your lender or refinance to a new one.

Talk to Murray Home Loans if you would like to know more, or find out how your loan compares in today’s market.

Links:

RBA Interest Rate Decisions: http://www.rba.gov.au/monetary-policy/int-rate-decisions/2017/

RBA Inflation Target: http://www.rba.gov.au/monetary-policy/inflation-target.html

RBA Cash Rate Statistics: http://www.rba.gov.au/statistics/cash-rate/

Mortgages underpin record profits: http://www.smh.com.au/business/banking-and-finance/mortgage-headwinds-building-for-banks-analysts-20170907-gyctk6.html