Finance

How does an increased RBA interest rate affect you?

Firstly, a quick synopsis. We constantly read and hear about the RBA’s interest rate and how it will affect the economy, but how many of us know what it is?

Who are the RBA?

The Reserve Bank of Australia is a body corporate entirely owned by the Commonwealth of Australia. It is Australia’s central bank and its main role is to maintain the stability of the country’s financial system, with the public face of its role made manifest through its role in setting the cash rate. The cash rate is announced after each RBA board meeting, which is usually once a month, apart from January.

Reserve Bank of Australia

What is the RBA interest or ‘cash’ rate?

Despite some common misconceptions, the RBA interest rate does not dictate the interest rates individual banks set for their loans (whether they are business loans, personal loans or home loans). Instead, the RBA interest rate is that which effects overnight loans in the money market.

How does this affect banks? Because they sometimes need to take out overnight loans to help fund their various transactions. Yes, banks sometimes run out of cash and that’s why they take out overnight loans, which have an RBA interest rate.

So, a low RBA interest rate (sometimes called a ‘cash rate’), in theory, drives further business by banks because they know that if they need to take out a loan to fund their own transactions they won’t have a large interest rate attached to it. If the cost of taking out a loan by a bank is low, then they are likely to take more risks through lending to more businesses and individuals and driving the circulation of money through the economy. Simple!
cash in a wallet

How does an increased interest rate affect you?

“Even though the RBA includes a range of considerations when setting the cash rate, including inflation, unemployment levels, retail performance and more,” says CEO of realestateVIEW.com.au, Enzo Raimondo, “it is the housing market that is having an increased and almost dominant influence on the cash rate.

“House prices in Sydney increased by approximately 70 per cent in the five years leading up to December 2016. When you compare figures like this against income growth (13 per cent in the same period), it is understandable that the RBA Board would see the property market as a key concern in their monthly meetings.”

If you are looking to take out a new mortgage, whether it be for a personal loan, the purchase of a property or the purchase/establishment of a new business, an increased interest/cash rate may affect your plans.

The future of the economy is hotly reported on by the media today, and the effects of any fluctuations in the cash rate, whether the cash rate goes up or down, can sometimes be exacerbated by the media’s interest. An increased cash rate may mean higher interest rates for your mortgage, even though the same can be true even if the cash rate remains the same. This was the case in January 2017 when certain banks increased their lending interest rates in expectation of an RBA cash rate rise, the rising cost of house prices and new regulations restricting risky lending.

An increased interest rate that tries to curb the surge in housing investment (fuelled by the low cost of borrowing) runs the risk of affecting single-home borrowers and new home owners, as their monthly mortgage rates increase. For those who have taken out interest-only loans in the hope of entering the property market, a higher interest rate increases the risk of their ability to manage their cash flow and maintain their ability to pay back their loan. In an economic environment where investment has been fuelled by historically low RBA cash rates, any increase to the cash rate (an inevitability) risks destabilising the finances of those who have overreached, or stretched themselves too thinly, in their investments.

But of course, rising interest rates, while potentially constraining the finances of those already on the property ladder, can have an adverse and positive effect of helping potential home owners save. An increased cash rate set by the RBA often results in increased interest rates on savings deposits. So for those saving for a house, you may actually want an increase to the cash rate because it curbs spending in the economy and fosters saving.

READ MORE: How can a stagnant RBA interest rate affect you?

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