If you have a mortgage, here's why you should be paying attention to the RBA's latest announcement

The Reserve Bank of Australia (RBA) kept the official cash rate steady today, but it seems lenders may be preparing to for rates to rise in the longer term. Canstar finance expert Steve Mickenbecker says that borrowers are “nervous” about the possible state of the housing market in 2022, and that the current low fixed rates offered by lenders may not stick around for much longer. Here’s why you should be paying attention, even if you don’t normally follow interest rate movements.

“I have a confession,” a friend said to me recently. “I know I should, but I just don’t pay attention to the interest rate on my home loan.”

“Really?” I asked. “You don’t ever check up on it?”

We were at a birthday barbeque, having a deep and meaningful chat about the housing market, when my friend admitted this.

“I mean, interest rates go up or they go down, a little bit more money or a little bit less comes out of the home loan account each month, and that’s it. I should really try and get my head around how it all works but there’s just so much else going on. Is that bad?”

It’s not, I assured my friend. If this conversation sounds like you, then there’s nothing to be ashamed of. Given the enormous amount of information that comes at us every day, even with the best of intentions, it’s easy to adopt an ‘out of sight, out of mind’ attitude, even sometimes to important matters that affect us financially.

Right now, though, if you are paying off a mortgage or thinking about getting into the housing market, it is worth paying close attention to the moves that the RBA and home loan lenders are making, and their potentially serious implications for everyday Aussie borrowers in years to come.

Here’s a brief explainer on how the RBA sets the cash rate, why it has remained steady for so long, and why a future movement in the cash rate could potentially spell concern for some Aussie homeowners as mortgage repayments go up.

What is the RBA cash rate?

The RBA is our nation’s central bank, and its role is to make monetary policy and maintain the strength of the Australian financial system. Every month (except January), the board of the RBA meets to set the cash rate, which is the official interest rate that banks and other lenders have to pay on money that they borrow. The board may choose to lower the cash rate to try and stimulate borrowing and spending in the economy, or raise it to keep inflation under control.

It is important to keep in mind that the cash rate is different from the interest rates paid by everyday Aussies, like people with home loans. The two are connected, however, in that if the cash rate is high, then banks and lenders typically pass this on by charging higher interest rates to customers and paying higher interest rates to people with savings accounts and term deposits. Likewise, if the cash rate is low, then banks and lenders will theoretically charge lower interest rates to borrowers and pay less to depositors. This is not always the case, though.

Why is the RBA cash rate currently so low?

At present, the official cash rate is as low as it has ever been, in an attempt to combat the economic fallout of the COVID-19 crisis. The cash rate actually dropped twice in 2020 – in March, the RBA board met and dropped it to 0.25%, before meeting again in November, where it was lowered again to the current level of 0.10%. It was expected to remain at this level until at least April 2024, although given recent signs of economic recovery, RBA governor Philip Lowe has indicated that it could rise again sooner.

With COVID-related restrictions lifting in major cities, and particularly with Sydney and Melbourne emerging from long periods of lockdown, the RBA seems to believe that the economy is recovering, and has suggested the cash rate could go up as soon as late 2023, provided wages growth improves by then. At its December meeting, the board said the cash rate will not increase until actual inflation is sustainably within the 2% to 3% range, and the labour market is tight enough to generate wages growth that is materially higher than it is currently.

The board said that this is likely to take “some time”, but that it is prepared to be patient. Nonetheless, many home loan lenders have pre-emptively begun shaking up their interest rates, in what could be a sign of interesting times ahead for borrowers.

How do lenders determine their interest rates?

While the RBA’s monthly cash rate announcements are important and do partly influence how banks and lenders set their interest rates, they are not the be-all and end-all. As the RBA explains it, there are three main factors that can go into how banks and lenders determine their interest rates, including whether they choose to put them up or down.

These factors are funding costs, competition from other banks for borrowers, and the risk that borrowers might default on their loans and not repay them. In brief, here’s how they work:

• Funding costs: Funding costs are the interest rates that banks pay to borrow money and to people who deposit savings with them. If funding costs increase, then a bank may wish to increase lending rates in order to maintain profitability; raising rates, however, may mean that borrowers will want to borrow less. Balancing these two considerations is important for banks’ overall profitability.
• Competition from other banks: Banks and lenders exist in a competitive marketplace, and as such, they must compete for borrowers’ dollars in order to maintain their profits. This can influence the movement of interest rates, insofar as banks and other institutions may choose to cut them (or raise them on savings accounts and term deposits) to attract customers.
• Risk of default: Before banks and lenders will lend money to a prospective borrower, they will assess the risk of this borrower being unable to pay the money back. If a bank or lender perceives a certain type of lending to be riskier, meaning that the chance of borrowers defaulting is higher, then they will raise interest rates on that type of lending.

Why are banks shaking up interest rates while the cash rate is going nowhere?

In recent weeks, Australia’s major banks have all shaken up their interest rates, with Canstar data showing many have recently cut rates on their variable and short-term one-year fixed products, while raising rates on other products like three- to five-year fixed loans. Why would they be doing this when the RBA’s cash rate remains unchanged? One simple reason may be that lenders are trying to encourage borrowers through the door with low rates while house prices are still high, on the understanding that rates will rise in years to come.

Generally speaking, when you buy a home with a fixed-rate mortgage, at the end of your fixed term you will move onto a variable rate (unless you choose to refinance). Say, hypothetically, that you purchase a house and sign up for a low one-year fixed rate mortgage. At the end of that term, you might well move onto a variable rate, and with the prospect of rate rises on the horizon, it seems logical that lenders might want to move borrowers onto variable rate products, where interest rate rises in years to come will mean higher repayments for borrowers.

Rising rates coupled with rapidly rising house prices could spell trouble for borrowers, with some experts recently expressing concerns that borrowers could find themselves in mortgage stress in years to come.

How are Aussies feeling about the housing market?

House prices have been on the rise across Australia this year – recent Canstar research shows the extent of this growth, with data showing that the median Aussie house price rose more than 25% in the year to October 2021, arriving at around $675,000. Experts are divided on whether house prices will drop by 2023, but those who have bought in the current hot market and those who are already paying off large home loans could well see their mortgage payments increase.

A recent Canstar poll found that many Aussies are concerned about the prospect of rate rises in years to come. 15% of the 2,124 people surveyed said they expected a rise in mortgage stress – or difficulty in covering both household bills and home loan repayments – in years to come. Recent Canstar research found that a full percentage point rise in the RBA cash rate could see Aussies with a $1 million mortgage experience more than a $500 rise to their monthly repayments. In a hot housing market, with the median house price nudging $700,000, this has the potential to be concerning.

Banks may be anticipating an RBA rate hike

RBA Governor Philip Lowe has said the RBA is in no rush to lift the cash rate, even if doing so could curb the growth in house prices.

“A lift in interest rates now would take some of the steam out of the housing market, but it would also mean fewer people will have jobs and wages growth would be even weaker than it currently is,” Dr Lowe told journalists last month. “That doesn’t sound like a good trade-off to me.”

Nonetheless, according to Canstar finance expert Steve Mickenbecker, Aussies are becoming “nervous” about the outlook for the property market in 2022.

“47% of survey respondents [are] anticipating slower price rises, increasing interest rates, higher levels of mortgage stress and foreclosures, [while] only 12% see these measures improving,” he said.

“The signs of a slowdown are also in the latest data releases, with Australian Bureau of Statistics figures showing home lending in October decreased for home buyers, leaving only investors accelerating, and the pace of house price growth slowing once again in November.”

“With 23% of Australians expecting an increase in foreclosures and mortgage stress, even before we have seen the cash rate go up, it seems there is limited confidence in our ability to absorb a sustained increase in home loan interest rates.”

“In spite of a cash rate that hasn’t moved for a year, interest rates are on the march in both directions, heading down for variable rates and up for fixed rates – a sure sign that the market expects the Reserve Bank to move up in the coming 12 months or so.”

“The fixed interest rate bargains are disappearing from the market for terms beyond 12 months, with nearly all of the competitive action happening in variable rates that the banks can increase at any time.”

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