Interest rates 101! We’re covering the basics so you don’t get caught out
Interest rates, interest rates, interest rates. Some days, that’s all I hear in my line of work! But what does it even mean, and specifically, what does it mean for you?
What is an interest rate?
If you’re an avid saver, interest may be that wonderful little (or large) sum of money the bank rewards you each month for saving money with their institution. In short, this type of interest is positive, and gives money to you.
On the other hand, the kind of interest we’re dealing with when we talk about home loans is the kind no-one really likes, because it’s the type you pay back. It’s the ‘penalty’ for borrowing money you didn’t have to begin with, and is a lender’s way of making a profit on the large sum of money they’ve loaned you for the purchase of your house, car, holiday – whatever the case may be.
Don’t forget though that there is good debt and bad debt. Interest paid on good debt (such as a residential home purchase) is worth paying back to the lender. It’s very different from credit card debt. But I digress…
How are interest rates calculated?
Home loan interest rates are typically based on the cash rate set by the RBA, which is responsible for issuing Australian currency and establishing the country’s monetary policy for financial stability.
The cash rate is reviewed on the first Tuesday of every month, and is announced by the RBA to take effect the following day. It’s a good idea to keep tabs on these updates to see if you need to adjust your budget going forward.
Home loan interest rates: now and then
In the 1990s, borrowers were paying a huge 17% interest on their home loans. In 2000, the average interest rate was just over 8%, and in 2020, the average interest rate sat around 4.5%.
In 2022, the average interest rate is approximately 3.32%, so certainly a lot less than the whopping amount borrowers were hit with in the 90s! However, record-low rates may be a thing of the past, with the Reserve Bank of Australia (RBA) recently increasing the 0.10% cash rate by .25 base points.
How an increase in interest rates can affect your finances
“There’s a slight rise in rates… so what?” I hear some of you say. Well, while 0.25% may look like nothing on paper, for buyers and owners, this ‘slight’ increase could mean hundreds of dollars more in mortgage repayments per month. Not too bad if you’re cashed up – but most of us aren’t.
Let’s break it down. With interest rates increasing by 0.25%, it could mean an extra $65 per month on a $500,000 loan over a 30-year term. That’s an additional $23,400 throughout the duration of your loan period, or an extra $780 per year.
It’s not unusual for borrowers to take out a $1 million home loan these days to secure their modest 3-bedder dream home. But with that ‘slight’ increase on the cards, that’s an extra $131 per month… an extra $1,572 per year… an extra $47,160 over a 30-year period…
GULP! This is exactly why it’s so important to understand interest rates and how they work.
Interest rate cuts
One question I hear quite often is, “Is it true that some banks don’t pass on the interest rate cuts?”
This is a tricky one to answer or predict, as sometimes banks will pass on interest rate cuts in full, while at other times, they won’t.
It is the discretion of the individual lender to decide whether they’ll amend the home loan rates for their customers; this can look like a cut to a bank’s fixed-rate loans but not their variables, or it could be the reverse.
The cuts could take place immediately, or weeks after the fact. Lenders may even raise or lower their interest rates regardless of the latest announcements from the RBA.
There is no clear answer on this one, so it is important to do your research on your lender or bank before taking out a loan, get your broker’s professional opinion, and take your time to make a wise decision at the very start.
Don’t settle for more. Negotiate your interest rate!
Monitoring interest rates to ensure you’re not paying an arm and a leg can be really overwhelming, but never fear.
With sound advice from a professional, you can try negotiating a better interest rate with your lender directly, should they choose not to pass on a rate cut.
You can also consider switching to another lender who is offering a better rate. That said, there are discharge and break fees to be taken into account here, as well as establishment fees and stamp duty, so as always, take your time making such decisions.
This is all really confusing, right? There are always several factors at play with every individual lender, and each will work differently, so be sure to read all the fine print before signing on the dotted line of your home loan application.
Ask your broker to explain every single detail so you know what variables to watch out for in your home loan, and remember that at Kitty & Miles, we are here for you every step of the way! Give us a call or shoot us an email, and we’ll clarify any questions you may have in the ever-changing realm of interest rates!