Find out what affects your home loan interest rate.
A crucial component which has an influence on how much you’ll pay on your home loan is the interest rate. When borrowing money, you should be aware of the rates that your lender implements, as this will determine how high your repayments will be. Interest is the charge or cost applied to the amount of money borrowed, and is traditionally measured as a percentage per year of the amount borrowed.
The Reserve Bank of Australia (RBA) is the Australia's central bank and is responsible for keeping track of the country's official cash rate. The Reserve Bank is also responsible for moving the cash rate to help manage the country's economic inflation. The cash rate is raised or cut by 'basis points', and is changed or held at the same rate every month at the RBA’s cash rate meeting.
The cash rate is crucial because it can, alongside other economic factors, affect the interest rates your lender charges, and therefore the repayments you’ll owe on your home loan each month. The official cash rate, along with the cost of funding, can cause your lender to raise or cut rates after the RBA makes a cash rate decision or at any point that they feel a rate movement is necessary.
How does the official cash rate effect home loan rates?
The board of the Reserve meets every first Tuesday of the month (except for January) to discuss how to properly approach Australia's monetary policy. A press release explaining this decision is released by the Governor. This decision can affect the country's economy, which in turn influences different aspects of Australia's financial materials including deposits, bank rates, bonds and stocks, mortgages, and other similar costs.
Banks adjust their fees, costs and charges according to the set cash rate. As mentioned, home loans are one of the products which are more strongly affected as mortgages are generally much larger than other debts or savings.
Savers can also be affected by cash rate movements. Banks will generally be quick to lower or raise their savings and term deposit interest rates in line with what the RBA decide.
What other factors affect home loan rates?
While the RBA plays a big role in the determination of bank fees and costs, their decisions are only one factor. Changes in the RBA’s policy doesn't necessarily mean a parallel change in home loan interest rates. Other factors come into play when home loan rates are being determined.
One clue we have into this is through ANZ, one of Australia’s big four banks. ANZ has their own rate meeting on the Friday following the RBA decision. They also make use of their own criteria to determine these rates, which give us a clue about how other lenders decide their rates. The five criteria ANZ use when deciding on interest rates are:
- Making sure that the returns of customer savings and investments are attractive and kept secure;
- Coverage of the cost they pay in interest when lending out funds;
- Keeping ANZ competitive to attract more customers and businesses to help manage costs;
- Consideration of the country's economy and the financial standing of their customers;
- Keeping ANZ within the regulatory requirements of the country's banking standards.
What can you do to minimise interest regardless of the RBA cash rate?
While there's not much you can do to control the cash rate or the economy, there are ways that you can minimise the impact of fluctuating interest rates on your home loan. Here are a few things you can look into to start.
Use an offset account. An offset account is a special type of transaction account that is linked to your mortgage, and you can use it as you would any other account. The main difference is that the amount in this account lessens the amount you have to pay towards your mortgage interest. If you have $40,000 in your offset account and you have a mortgage of $500,000, your interest will be based on the balance of $460,000. The more money you have in this account against your mortgage, the less your interest will be.
Extra repayments. Some lenders allow you to make extra repayments against your home loan. This is when you pay not just the loan repayment due for the payment period, but add in extra amounts. This pays off your debt faster as more of your payment goes towards the outstanding loan amount and less goes towards the interest due. Paying your loan off faster means you’ll pay less interest over the course of your loan. Note that this option may not apply for fixed rate home loans.
Find a cheaper interest rate. You can get a cheaper interest rate on your home loan in two ways. First, consider moving to a new lender. Many offer introductory rates that make the move pretty easy, but make sure that their rates after this period are still reasonable and meet your needs. The second way is to ask your current lender for a better deal, such as a discount or fee waiver. You can also ask them to give you a better loan to avoid the costs of refinancing.
Pay on time. Interest builds up when you miss a payment, and you'll end up paying for more than what you actually owe. Paying on time keeps you within budget. Also try to avoid refinancing to longer loan terms, as even though this can reduce the cost of your repayments, it can increase the interest you pay over the life of the loan.
While the RBA cash rate can have a bearing on your home loan interest rates, it’s not the only ingredient which goes into your rate. Sometimes switching from one lender to another, or using features such as an offset account can have a bigger impact on your interest rates.