# What effect does a rate change have on a home loan?

DOMINIC BEATTIE
20 January 2017
Find out about the relationships between the cash rate, interest rates and, ultimately, the cost of your home loan.

## What is the cash rate?

The Reserve Bank of Australia (RBA) is responsible for monitoring and altering the official cash rate for Australia. This cash rate is the market interest rate on overnight loans between financial institutions. The RBA can either raise or cut the official cash rate by a measure of ‘basis points’ in an effort to manage the Australian economy – specifically, inflation.

## Interest rates, and a rate change’s effect on mortgages

It’s important to note the potential significance of a rate change’s effect on mortgages. The RBA’s cash rate has a strong influence over the interest rates that financial institutions charge customers for loans – most notably variable rate home loans. Whenever there’s cash rate rise or cut, the interest rates that banks charge on their home loans will broadly move in line with the change.

Note that banks don’t actually have to follow the cash rate change when it comes to interest rates, but it’s usually in their best interests to do so. A bank that fails to pass on a cash rate cut to its variable mortgage holders, for example, risks losing customers and damaging its public image.

So given the economic climate in Australia and overseas at the time, customers could be in store for a rate cut or a massive spike over the term of their home loan – but what effect does a rate change have on a home loan, and what would this effect mean for home owners?

## What effect does a rate change have on your home loan?

A rate change will usually mean your interest rates go up or down. The table below models some of the different possibilities when it comes to a rate change’s effect on mortages; for modelling purposes, assume the current interest rate being paid by a borrower is 4.25% p.a.:

Table: Cash Rate decrease effect on home loan repayments
Loan Amount
\$150,000 \$300,000 \$500,000 \$750,000 \$1,000,000
Current Monthly Repayment* \$1,088.80 \$2,177.61 \$3,629.35 \$5,444.02 \$7,258.70
0.25% interest rate decrease* -\$24.09 -\$48.17 -\$80.29 -\$120.43 -\$160.58
0.50% interest rate decrease* -\$47.93 -\$95.87 -\$159.78 -\$239.67 -\$319.56
0.75% interest rate decrease* -\$71.54 -\$143.07 -\$238.46 -\$357.69 -\$476.92
1% interest rate decrease* -\$94.89 -\$189.78 -\$316.31 -\$474.46 -\$632.61
Source: CANSTAR
*Current monthly repayments based on 25 year loan applying a starting interest rate of 4.25% p.a.. Additional fees and charges are not considered.

This data shows how a decision to lower the official cash rate would drastically affect home loan monthly repayments (especially more expensive ones) if banks were to pass on this rate cut to customers. In short, customers would be saving potentially hundreds of dollars per month.

You can work out how a lower interest rate would benefit your monthly repayments using our Home Loan Repayments Calculator:

Given different circumstances though, the rate change could always go the other way – meaning customers would be in store for an increase in their monthly payments. Therefore it would be unwise for home-owners to heavily rely on rate cuts to keep their mortgage under control. Many are betting on the new year seeing the start of an upwards trend as far as the cash rate goes.

Also keep in mind that a rate cut isn’t all good news; it may have a not-so-positive impact on your superannuation and savings accounts!

It’s also worth noting that since the Global Financial Crisis (GFC), the cost of borrowing has increased to the point where banks will only absorb costs up to a point. In an effort to remain profitable, banks may autonomously pass on rate changes – or completely ignore rate changes despite the RBA’s decisions.

Therefore, the best course of action that anyone can take is to not rely on a rate change’s effect on their mortgage, keep on top of their mortgage repayments, and shop around for the best interest rate possible. Customers could even consider switching to a fixed rate mortgage so they only have to pay a set interest rate for the term of their loan.