Explainer: Interest rates and the RBA
Strap in! Explaining the RBA is super exciting!
OK, maybe not, but interest rates are always attracting … interest.
The RBA meet 7 times a year (they’ve given themselves four months off as of this year) to ponder interest rates. Media, homeowners and – especially – buyers approach these events with speculation and – after the announcement – analysis. What does it all mean?
These RBA meetings set the ‘cash rate’. But, as every borrower, saver and credit-card user knows, this is very different to the interest rates most people see.
Cash Rate Explained
Banks lend to each other. All the time. Like us (sort of) they need to manage their cash flow. Plus, the government makes them always have a set amount of ‘cash reserves’ handy.
The cash rate, then, is the amount of interest banks are allowed to charge each other on these bank-to-bank loans. Set by the Reserve Bank of Australia (RBA) the cash rate is also sometimes called the base interest rate or the overnight bank rate. See? We said this would be exciting!
But why is your mortgage, credit card or savings interest rate different?
Interest Rates Explained
Banks and other financial institutions regard money in a different way to us.
- Banks hold deposits (usually in savings accounts or term deposits) from their customers. They then have to pay interest to those customers. They call it a ‘funding cost’.
- Financial institutions use this money to lend to people and businesses wanting access to more money than they have in the bank. Buy a business, buy a house, buy a boat, have a holiday… The interest they charge on these loans is called a ‘lending rate’.
Rates, Rates, and Other Rates
Deciding which rate to charge a home-loan borrower versus someone wanting a jet ski is based on two main things:
- Risk: What’s the chance that the borrower can’t repay the loan?
- Profit: How much can the lender make on the deal? If everyone paid off their loan immediately, there’s no profit. If they can’t pay at all, that’s bad for their business.
Lenders take a hard look at income and credit history to decide whether, and how much, to lend to a borrower. The interest rate they charge is basically all about the overall risk of people being unable to service their loan (defaulting).
On the other hand, the risk of Westpac being unable to repay a loan to NAB is tiny. So the ‘cash rate’ is lower than a typical lending rate.
Worried About Your Rate?
Living with financial stress is difficult. If you are looking to find a place to live – or needing to reduce your current loan costs – the Mortgage Broker Group can help you secure a home loan that will suit your financial situation.
Talk to the expert loan brokers at Mortgage Broker Group. Our service is always free for you, although lenders may charge fees for any loan you take out.