When the RBA cuts the official cash rate the rates on your home loan, credit card and savings account could all go down. Here's how it works.
The Reserve Bank of Australia sets the official cash rate, which is the interest rate for overnight loans provided to banks. The cash rate has a big effect on your home loan, credit card and savings account interest rates. A decrease in the cash rate typically means interest rates go down. Very good news if you have a mortgage but not so good for the interest you earn on your savings account.
On the first Tuesday of every month (except January), the RBA board meets to decide whether to raise the rate, drop it or keep it at the same level. This rate decision is based on a wide range of actors including consumer confidence, the strength of the economy, the housing market and the performance of the Aussie Dollar.
When the rate moves, it usually does so in increments of 0.25 per cent. When the RBA lowers interest rates, this is referred to as a drop in the cash rate.
What does an RBA cash rate decrease mean for me?
A decrease in the RBA’s cash rate can have a number of implications for Australian consumers, with rate drops influencing different financial products in different ways.
Most lenders will typically pass on the RBA’s rate cut to their own home loans, although some will be a little more tardy than others. If you have a variable rate home loan and your lender passes on the rate cut, you’ll be able to enjoy a noticeable reduction in the amount of interest you have to repay toward your loan.
However, if you’re locked into a fixed rate loan, you’ll have to wait until the fixed rate period ends before you can take advantage of lower rates. When the fixed period is up, you may wish to negotiate a better rate or see if another lender might be willing to offer you a more attractive deal.
Another effect of a cash rate decrease is that more people are likely to enter the property market. As lower interest rates means home loans become more affordable, home buyers will likely experience increased competition in the real estate market.
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What if my lender doesn't pass on the cut?
If your variable rate doesn't change then it's time to look around for a lower rate and refinance your mortgage. A 25 basis point cut can make quite a difference to your repayments. If you had borrowed $400,000 on a 30-year mortgage with a 4% rate your repayments would be $1,910 a month. A 25 basis point cut down to 3.75% would reduce your repayment to $1,853 per month, saving you $684 a year.
If banks agree to pass on the interest rate cut and lower their credit card interest rates - which doesn’t always happen - this can be good news for cardholders. A lower interest rate on your card means you will have to pay less interest on the purchases you make, which means it will be more affordable to spend your money and easier to pay off your debt.
Decreases in the cash rate are designed to encourage consumer spending by making credit card purchases more affordable. However, if your bank doesn’t lower your credit card interest rates, it may be worthwhile looking for a different card that offers a better rate and other attractive features. You may even be able to take advantage of a 0% p.a. introductory rate on balance transfers to help you get out of debt quicker.
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If you’ve got money tucked away earning interest in a savings account, an RBA cash rate decrease may not be the news you’ve been hoping for. You’ll want your savings balance to be earning interest at the highest rate possible, so any drop in interest rates will see the speed with which you can build a sizable savings balance slow down.
However, if your funds are locked away in a term deposit, you won’t feel the effect of the rate decrease until your deposit matures and you can access your funds. Of course, the fixed nature of a term deposit means you won’t be able to enjoy the benefits of any rate hikes should they occur.
But with careful planning and a sensible approach to your personal finances, an RBA cash rate decrease doesn’t have to cause any pain for your hip pocket.