The official cash rate and the interest rate are not one and the same, although the cash rate significantly impacts the rates lenders offer on their financial products.
Keep on reading to find out more about Australia’s cash rate vs interest rate, how they differ and how one affects the other.
What Is the Cash Rate?
Put simply, the cash rate is the country’s official interest rate. It represents the interest banks and loan providers pay on unsecured overnight loans between each other.
Thus the RBA cash rate serves as a benchmark for all other interest rates, starting from home loan interest rates and savings account rates to the exchange rate and term deposit rates.
The cash rate is determined by the RBA in a board meeting on the first Tuesday of every month (excluding January). The RBA board can decide to increase, reduce or hold the official cash rate target depending on current economic indicators, such as inflation, employment, economic growth and global financial conditions.
What is Australia’s cash rate?
In November 2022, the RBA board announced an increase in the official cash rate by 0.25%, bringing it to 2.85%. This is the seventh consecutive month that the RBA has raised the cash rate after holding it steady since December 2020.
The next RBA board meeting is set on 6 December, with experts predicting another rise in the cash rate target. In fact, the cash rate, and by extension, the home loan interest rate is forecast to go up in Australia again at the start of the new year, peaking in March 2023 at 3.85%, up by 370 basis points since the start of 2022.
What factors impact the cash rate?
It is the responsibility of the RBA to ensure the stability of the Australian dollar and employment rate, as well as to contribute to the economic prosperity and welfare of the Australian people, which means that it adjusts the cash rate according to these three principles.
Should unemployment rates in the country become too high or economic development slows, the RBA board will normally reduce the cash rate. This will make it easier for companies to get funding and create jobs in the process—for example, the RBA lowered the cash rate to 0.10% in November 2020 in an effort to offset the economic effects of the COVID-19 crisis.
The COVID-19 pandemic and related lockdowns/border closures were also the reason why the board kept the cash rate steady between November 2020 and May 2022 despite rising property prices and inflation.
On the other hand, when inflation gets too high, as is the case now, the RBA increases the cash rate to help limit Aussies’ spending and maintain their buying power.
RBA cash rate history
Cash Rate vs Interest Rate: How Does the Cash Rate Affect Interest Rates?
As mentioned above, the cash rate determines how much interest banks pay on the money they borrow, so it is closely tied to the price of financial products. When the RBA cash rate increases, it will cost banks more to transfer money between each other—costs that are usually passed on to the customers via higher interest rates on home and personal loans.
Banks and lenders are not obligated to change their own interest rates on loans and savings when the cash rate fluctuates, although they often do. For instance, the four big banks, as well as several other lenders, increased rates in May 2022 in line with the 25 basis points hike in Australia’s cash rate or stated that they plan to do so.
The cash rate is not the only reason for rising or falling interest rates. The interest rate is also determined by financial market conditions, capital requirements, the level of competition in the lending market and risks related to certain types of loans.
What happens to home loan rates when the cash rate is lowered?
When the cash rate is low, borrowers can expect more favourable interest rates and terms on home loans.
In fact, even a slight reduction in home loan interest rates can lead to more people taking out mortgages and in turn a surge in property prices. Such was the case in 2020 when the cash rate was at a low 0.10%—housing prices soared as did the number of first-time borrowers.
A lower cash rate is also beneficial for those looking for a refinancing deal—lenders are likely to offer better terms in order to stay competitive on the market. So, if you are looking to get a home loan line of credit or switch to another lender, the best time to do so would be when the cash and interest rates are low.
What happens when the cash rate increases?
On the other hand, when the cash rate increases, lenders will raise home loan rates which leads to higher mortgage repayments. The recent hike in the cash rate for instance will particularly affect those who took out a home loan with a variable interest rate last year (when interest rates were at a record low), as well as first-time borrowers.
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Here is an example of how the cash rate impacts monthly mortgage repayments: Let’s say you have a $500,000 home loan. When the cash rate increases by 0.25%, your monthly mortgage payments would amount to $2,384. A 0.1% cut in the official cash rate, on the other hand, would reduce mortgage payments to $2,012 a month.
$300 may not seem like a huge difference, but considering that payments are stretched across the life of the loan, a rise in the cash rate could drastically increase your mortgage payments.
Additional factors that impact mortgage interest rates
Interest rates are not to be neglected as even a cheap loan can rack up thousands of dollars in interest over time. However, the cost of a home loan is not dependent on the interest rates alone.
How much you will pay in monthly mortgage instalments depends on your loan-to-value ratio, your deposit, your annual income and the mortgage provider you choose, which makes it all the more important to look at several loan comparison rates instead of going for the first offer you find.
What does a cash rate increase mean for savers?
The cash rate also affects interest rates on savings, i.e. the money you earn from savings accounts and term deposits.
When the cash rate increases, some banks may choose to raise the rates on savings. Thus in September 2022, when the RBA board raised the cash rate by 0.50 basis points, the average interest on an online savings account of $10,000 increased by 0.90% and 2.25% on bonus savings accounts.
Likewise, term deposit interest rates rose to 1.65% p.a. on 3-year term deposits, 1.50% on one-year deposits and 0.85% p.a. on 6-year term deposits.
Put simply, a higher cash rate can work out great for savers, whereas a lower cash rate may deter people from putting their savings in the bank.
Bottom Line: Why Should You Care About the Cash Rate?
As stated above a change in the cash rate is not the only factor affecting your mortgage repayment, but understanding the cash rate vs mortgage rate difference and how one affects the other can help you determine if you will pay more or less for your loan.
Factoring in the cash rate in your home loan calculations is easier said than done, though, due to the large number of variables that impact economic growth and stability in the country. That’s why it may be beneficial to talk to a mortgage broker or financial planner who can help you find the right mortgage product for your needs and circumstances.
1. What are the current home loan interest rates?
According to Canstar, as of 31 October 2022, the average variable interest rate for owner-occupied homes is 5.18%. The average fixed rate ranges from 5.28% for a one-year loan to 6.44% for a 5-year mortgage.
2. Why are bank interest rates higher than the cash rate?
The interest banks charge on loans needs to be higher than the interest rate they pay to get funds, i.e. the cash rate if they want to make a profit. Banks usually source funds from the domestic open market, that is they borrow money from each other and the cash rate is the interest they pay on those transactions.
3. What is the lowest cash rate Australia has had?
The lowest cash rate on record was in November 2020 when it was sitting at 0.10%. The RBA held the cash rate up to May 2022 when it rose by 25 basis points and then again by 50 basis points every month until September 2022. The 50 basis points hike, GDP statistics reveal, was the single biggest increase in Australia’s cash rate in the past 22 years.
