Interest Rate Rise: What it means for homeowners

Worried about interest rate rises? You’re not alone. The Reserve Bank’s announcement on 03 May 2022 to increase the cash rate target has most homeowners on edge. When the cash rate rises, unfortunately, home loan interest rates also rise. But what does all this mean? In this post, we’ll explore what an interest rate rise means for homeowners. You’ll learn:

• what a cash rate is,
• what interest rates are and why they change,
• why interest rates are rising in Australia,
• what this means for your home loan repayments 
• if an interest rate rise will impact property prices,
• how you can prepare for an interest rate rise

Now we understand that this post might be a little, shall we say ‘dry’? But, it’s important! So grab a cuppa, and let’s dive in

What is a cash rate?

The cash rate is the interest rate that a bank pays to lend funds from other banks in the money market on an overnight basis to meet their daily cash needs. As the central bank for Australia, The Reserve Bank is the primary decision-maker when it comes to Australian monetary policy, with a duty to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people. 

Meeting on the first Tuesday of every month (except January), the RBA considers various factors (like employment rates, economic growth and inflation) to decide whether the official cash rate should change. The recent decision to increase the official cash rate by 25 basis points was the first time in 10 years that the RBA decided on an increase. 

What are interest rates, and why do they change?

Now that you know about cash rates, you’re probably wondering what they’ve got to do with interest rates. Decisions to increase, decrease or hold (leave ‘as is’) cash rates have flow-on effects on other areas of the economy, including the interest rates set by banks for their variable loan products.

Interest is what a bank charges when they lend you money for products like credit cards, personal loans and home loans. The lower the interest rate, the less interest you’ll pay over the life of the loan for lending the money. The interest rate set by the bank is influenced by the cash rate set by the RBA. 

According to Mortgage Choice, when the cash rate is low, interest rates on your mortgage will feel more affordable because you’re paying less interest each month on your borrowed money. However, when the cash rate increases, banks’ interest rates follow, and the cost of borrowing money is more expensive. Likewise, a decrease in interest rates often leads to a rush of people buying a property because home loans are seemingly cheaper. The opposite is true when an interest rate rise occurs. 

Are interest rates rising in Australia?

Interest rates are influenced by the behaviour of the cash rate – this part, we already know. But, it’s important to acknowledge that the announcement made by the RBA was to increase the ‘cash rate target’ to 35 basis points (an increase of 25 basis or percentage points). Banks will take this into account when considering whether to increase interest rates. Still, they also consider several other factors when deciding to increase interest rates, such as the competitive environment, funding costs and customer feedback.

In saying this, since the announcement to increase the cash rate target was made, the big four banks (CBA, NAB, Westpac, and ANZ), as well as some smaller banks, have stated that they will be passing full the RBA’s increase in the cash rate ‘in full – it may have already happened. You can expect the variable interest rate on your home loan to increase by the same 25 percentage points that the RBA applied to the official cash rate target. What does this mean for you? If your interest rate is currently 4%, you can expect it to rise by 25 percentage points to 4.25%

How will an interest rate rise affect my mortgage repayments?

This depends on your bank, the type of home loan product you have, how much you borrowed, and the amount you’re currently repaying. If you’ve chosen a fixed interest rate for your home loan (or a portion of it), the interest rate will remain unchanged for that fixed period, and so will your repayments (unless you opt to pay more etc.). However, homeowners with variable interest rates are likely to notice an increase in their repayments in line with their bank’s decision. According to 9news.com.au, where a bank has passed on the rate hike in full, the average borrower with a $500,000 loan and 25 years remaining will see their repayments rise by $65 a month. Someone with a $1 million loan will see their repayments rise by $130. 

Do interest rate rises affect the property market?

Yes. As interest rates rise, borrowing capacity and higher mortgage repayments weigh heavily on home buyers, and its likely buyer demand for property will reduce. 

Realestate.com.au indicate that typically when interest rates have risen in Australia, property prices have also risen. Yet as we clawed our way through the COVID pandemic, some national home prices experienced increases by up to 35% – a rate that would be difficult to sustain even without rising interest rates. And, we’ve already started to see signs of the market slowing.

Mark Bainey, chief executive of Sydney-based property developer Capio Property Group, indicated just after the RBA announcement that  ‘Buyer inquiry levels are down 50 per cent at the moment, so demand has essentially collapsed,” he said. Prices are remaining steady, but inquiries are always the best indicator of where prices are going. If inquiries are going down, then prices are going in the same direction. We’re prepared for it, but I think the outlook for the market is quite dire.”

Increased interest rates can understandably spook many home buyers, but if we’re looking on the bright side, it also means less competition and where there’s less competition, you’ll likely see reduced property prices.

How can you prepare for an interest rate rise?

Interest rates are rising; there’s no denying it. Follow these tips to help lessen the impact it may have on your bank account:

• Calculate how an interest rate rise will impact your home loan. If you’re not sure, talk to your bank or mortgage broker
• Review your budget – can you cut costs, or can you afford to make extra repayments now to lessen the impact of rate rises down the track? One option is to calculate what your repayments would be if your rate increased by one percentage point and start paying that amount if you can [Canstar.com.au].
• Talk to your bank or mortgage broker about other home loan products or options – like locking in a fixed rate for all or a portion of your mortgage now. 
• Consider shopping around for a better deal – some banks even off cashback for switching your accounts to them! It pays to do your research. 

The final word on interest rate rises

The rise and fall of interest rates is nothing new, but some homeowners may not have previously experienced higher interest rates. They will no doubt also impact many first home buyers. It’s important to understand your options and know what the likely impact is going to be on your circumstances. And, if you’re looking to get a foot in the property market sooner rather than later, we’d love to hear from you. Our experienced team of conveyancers are here to help you achieve your property goals. Get in touch with us on (02) 4056 1070, or get your free conveyancing quote online today