At its May board meeting on 3 May, the Reserve Bank of Australia (RBA) lifted the cash rate by 25 basis points to 0.35% in an attempt to curb surging inflation, which is rising at the fastest pace in two decades.
This is the first time the RBA made a change to the cash rate since November 2020 saying now was the right time to begin withdrawing some of the "extraordinary support that was put in place to help the Australian economy during the pandemic".
It said it was committed to doing what was necessary to ensure inflation in Australia returns to target, which will require a further lift in interest rates over the period ahead.
So what does a jump in the cash rate mean for you, and how much could future cash rate increases impact your financial situation? Let’s start to break it down.
What is a cash rate?
The cash rate is a figure set by the Reserve Bank of Australia (RBA), representing the interest that banks and lenders have to pay on the money they borrow. Each month (with the exception of January), the Reserve Bank of Australia announces whether the official cash rate will remain the same or move up or down, and this announcement has important ramifications for banks, lenders and everyday Australians.
The RBA takes a number of things into account when considering whether to change the cash rate. Generally speaking, factors that influence the RBA to move the cash rate include inflation, employment, and the growth rate of the Australian economy.
What does a cash rate hike actually mean for you?
While the cash rate has no direct impact on home loan interest rates, banks and lenders will typically pass on any cash rate raises to customers via mortgage interest rates. Equally, when the cash rate is low, lenders and banks will often lower interest rates across loans as a result.
In layman’s terms, for people with a mortgage their repayments will be higher as a result of the recent cash rate hike.
Predictions for the cash rate?
Economists are predicting that the cash rate will be above 2.5% by the end of this year. That means that the cash rate will increase by more than 2.2 percentage points.
If mortgage rates increase by the same amount – and it is entirely possible they increase by more than that as lenders look to repair their net interest margins – that would double the average rate on new loans from the current 2.5% to 5%.
That is a very steep increase. It would quickly take mortgage rates back to levels not seen since in almost a decade, in 2013.
Major bank forecasts are more conservative. They put the cash rate somewhere between 1% and 1.5% by the end of the year.
How much will interest rate rises impact home loan repayments?
We have already seen the four major Australian banks pass on the cash rate rise across their loans. The increase in interest rates will have a fairly modest impact – for now.
For a borrower with an average variable mortgage rate of 2.92%, based on February RBA data, that could cost an additional $68 a month on a $500,000 mortgage.
For a $750,000 mortgage, that’s the equivalent of around $102 extra a month, or $135 a month for a million-dollar mortgage.
In this calculation the borrower is an owner occupier paying principal and interest with 30 years remaining on their loan. It does not factor in loan fees and charges.
It’s not all doom and gloom.
While the increase in interest rates will no doubt add some financial pressure to households, for the most part, borrowers are well placed to manage this increase in repayments. Official data shows many households have built up significant savings and paid down their loans ahead of schedule.
If you currently have a fixed rate mortgage, the good news is that you are unaffected until the expiry of your existing loan.
If you are sitting on some cash or additional savings, there may be some investment opportunities that will place you in a better financial position.
If you are unsure what these changes mean for your individual situation and how best to navigate these rate rises, contact our team today to understand how we can assist you and ensure you are in the best possible position for your individual circumstances.