How Interest Rates Work
Whether it’s radio talkback, TV current affairs or just chat in the workplace lunchroom, there is a lot of interest in interest in Australia.
In the lead-up to the regular Reserve Bank of Australia meetings, there’s always speculation about whether interest rates will go up, go down or stay the same.
These RBA meetings determine the ‘cash rate’. But if you have a mortgage, a savings account or a credit card, you’ll know that this cash rate isn’t what you see on your interest statements.
Cash Rate explained
Many people might be surprised to learn that banks frequently lend money to one another. There are several reasons for this, including controlling daily cash flow and maintaining a fixed cash reserve that is mandated by law.
The interest rate that banks charge one another on these bank-to-bank loans is known as the cash rate, which is also referred to as the overnight or base interest rate.
What makes the cash rate different from home loan interest rates?
Interest rate fundamentals
If a person or organisation holds savings at a financial institution, that institution is required by law to pay interest. That interest is a ‘funding cost’.
The bank then uses these deposits to lend to customers. It might be a house or a car or even a holiday. They then charge interest on that loan, known as a ‘lending rate’.
So for lenders to make money and cover the risk of loan defaults, they make profit from the difference between the funding cost and the lending rate.
Risk and reward
Banks determine whether to lend money based on factors including income and credit history when a borrower asks for a loan or credit card. The risk of borrowers defaulting on their loan is also reflected in the interest rate they charge.
There is extremely little chance that another bank won’t be able to repay a loan. The RBA cash rate is therefore less than the interest on your credit card or house loan. There’s almost no risk that the lender won’t get their money repaid.
Personal borrowers are different. Since items like new cars, holidays and Uber Eats don’t increase in value (and aren’t worth much if they’re repossessed) lenders are more likely to lose money on credit card and personal loans. Property, on the other hand, often goes up in value. This is why credit card and personal loan interest rates are higher than home loans.
Talk to us
Speak with Mortgage Broker Sydney’s knowledgeable home loan brokers.
We can assist you in obtaining a house loan that will work for your financial circumstances, whether you’re looking to buy a place to live or are having trouble making your current loan payments. Interest rates are important, and there are several low-rate loans in the market. We can assess the market and find you a great deal.
While lenders may impose fees for any loans you take out, our service is always free for you.
Author: Marc Barlow
Role/Position: Director, Mortgage Broker Sydney
Marc has been a professional lender for 28 years. After beginning his career in 1990 with a UK Building Society, he moved to Australia where he held several different retail banking roles. In 1999 it became clear to him that a mortgage broker would eventually become an obvious choice for someone looking for a home loan so he took the plunge and became an independent broker. He hasn’t looked back since!
