Recent hikes to the cash rate by the Reserve Bank of Australia (RBA) have brought interest rates to the centre of everyday conversation for many Australians. If we look back through history, we can see the way the cash rate has moved - and how this has impacted home loan interest rates in turn.
What is the cash rate, and how does it affect my home loan?
Set by the central bank of Australia, the RBA, the official cash rate is an official number representing the interest rate that banks and lenders pay as borrowers. One of its principal aims is to control inflation.
Set in an RBA meeting on the first Tuesday of every month (apart from January), it is a benchmark for interest rates across all products. This means that financial institutions will use it in adjusting their home loans, personal loans, car loans, savings and term deposit interest rates, and more.
Products with variable rates, like variable-rate home loans, may feel the full impact of this as banks continually adjust their interest rates to reflect the RBA cash rate. Fixed rates will be protected from variations in interest rate changes for the duration of their fixed interest rate but may see a dramatic change at the end of the fixed term.
The main impact of an interest rate rise on your home loan will be an increase in your repayments. Since you will be paying more interest, your repayments will also increase. This is why a bank will test your loan serviceability before approving you for a home loan, as you need to be able to make repayments as interest rates rise.
On the flip side, if interest rates drop, your repayments could get smaller. This is all a part of the risk to consider when you choose a home loan!
What is the cash rate now, and where has it been in the past?
As of October 2023, the cash rate sits at 4.10%. This is the highest point the RBA cash rate has climbed to in 11 years.
Various factors, including inflation goals, employment levels, economic growth, and happenings in the international economy, influence current interest rates.
In 1911, the Commonwealth Bank of Australia was established as Australia’s central bank, functioning as what we know today as the RBA. It evolved into the financial institutions that we know today with the Reserve Bank Act of 1959, where the RBA became responsible for setting monetary policy.
Rates went about 10% for the first time in 1974 and remained there until roughly 1995. The highest the cash rate has ever been is 17.50% in January 1990. This finally dropped below 10% in September 1991.
Generally speaking, the cash rate in Australia has remained fairly stable over the past 20 years. From 1997 until today, the cash rate has remained roughly between 4% to 8% (with small outliers in the 2008 Global Financial Crisis, which saw it rise over 9%), where it remains today.
However, despite the RBA cash rate is similar to where it has been at other points in history, other factors have changed to make this affect home loans and lending rates differently.
What has that meant for mortgage rates and home loans throughout Australia’s history?
Despite relatively stable interest rates, many other parts of being a homeowner have changed in the past decades.
In 1990, with the cash rate slowly descending from 17.50%, you could have been a first home buyer with a variable interest rate on your home at 17%. This is a dramatic change from today’s average standard variable rate, which sits at roughly 6.3%.
This has meant that mortgage serviceability has improved. Serviceability refers to your capacity to make repayments not just at the current interest rate of your home loan but if the variable rate is to shift upwards by 2.5% - 3%. While this has improved with lower interest rates, home loan affordability has not.
The major difference is the loan amount needed, as property values have changed broadly since the 1990s. The average housing loan amount in 1990 was a meagre $71,000, compared to today’s much more daunting average home loan — nearing $600,000.
When you add this to the changing financial situations of many current and potential homeowners, it becomes even more challenging. The average annual salary in 1990 was $27,227, roughly 38% of the value of the average home loan. Now, the average Australian salary sits near $94,000. This is about 16% of the average owner-occupier housing loan. Even before factoring in interest rates, it takes a lot longer to save up a deposit for a home loan.
This is why recent rate increases have been met with such fervour. Though interest rates have been much higher throughout history, they have never been this high in such tight financial circumstances. It makes it a much tougher prospect to absorb the higher repayments that rate increases bring.
These combined factors have led to first-home buyers making up a much smaller percentage of borrowers, with the home loan market dominated by refinancers seeking lower interest rates. Investor loans have also formed a greater proportion of housing loans, with owner-occupier loans shrinking in prevalence.
How can I avoid the impacts of rising home loan interest rates?
If you are coming off a fixed rate to a much higher interest rate or want to know how you protect yourself against further interest rate hikes, there are options you can take that may help keep repayments lower.
- Consider a fixed rate: If you are finding your current repayments manageable or would like to avoid a further few percentage points of upwards movement, fixing your interest rate could be a good option.
- Choosing to refinance: Refinancing your home loan could be an option to get you a better interest rate as a starting point, better equipped for rate rises. This could be especially valuable if you are a borrower with one of the big banks (CBA, ANZ, NAB, and Westpac) - you may find lower rates with less storied lenders (though make sure they hold their Australian Credit Licence!). When choosing any home loan product, be sure to read any disclaimers and target market determinations and check the comparison rate against the advertised interest rate. This will factor in regular fees.
- Look into an offset account: Some home loans will offer the ability to put money into an offset account. This functions similarly to a savings account, but the money in this account goes directly into cutting down your home loan term. Though rising interest rates will still impact your home loan, an offset account could potentially offset these increases.
- Decrease your LVR: Decreasing your LVR, or loan-to-value ratio, feels like a no-brainer for homeowners. It can also help to prevent the worst impacts of rising interest rates. This is because the greater equity you have in your home and the less percentage you have owing, the less money you will need to pay interest on and the smaller your repayments will be. You can do this by making extra repayments.
- Opt for principal & interest over interest only: When it comes to choosing a home loan, it might be tempting to choose the interest-only option as your initial repayments will be smaller. This means that your continuing repayments will be higher and hit harder by rising interest rates. Choosing to go with the principal & interest option, however, means that you will pay less interest overall and have lower repayments over the life of the loan.
When will interest rates come down?
It’s hard to determine when interest rates will begin to trend downward again, especially with so many different predictions from the sources at hand.
Inflation remains higher than the RBA target, though it does seem to have slowed, so most economists tend to agree that another rate rise is likely for 2023. Predictions change weekly, but major banks tend to agree that we will see at least 1-2 more rate hikes as 2023 continues. Any of the main bank economists do not predict a downward trend until mid-late 2024.
With such tight constraints on homeowners and investors, it could be time to start considering what further rate rises might look like to you — and developing an action plan.
