Interest rates affect all Australians, which is why it is important to understand what interest rates are, why interest rates have gone up and how the changes in interest rates affect you.
Let’s look at a hot topic in Australia: interest rates. In the last 12 months, you might have noticed that the interest rates have gone up. But why? We’re going to look at this question now reviewing interest rates, inflation, the Reserve Bank of Australia’s role in all this, and what it actually means to the average Aussie.
What are interest rates?
First, let’s talk about what interest rates are. Simply put, an interest rate is the cost of borrowing money. When you take out a loan, such as a home loan, you agree to pay back the amount you borrowed plus an additional percentage, which is the interest rate.
The interest rate can fluctuate depending on a variety of factors, such as inflation and the economy. You would also hear interest rates talked about in relation to car loans, credit cards, and personal loans. However, a mortgage is generally a household’s biggest debt, so that’s where an interest rate rise really bites.
What is inflation?
Our next topic to look at is inflation. What is inflation? Inflation is the rate at which the general level of prices for goods and services is rising. Inflation impacts the purchasing power of you and me in short.
For example, if you used to pay $2 for a loaf of bread, but now you must pay $2.50 due to inflation, you’ll have to either pay more for the same amount of bread or buy less bread with the same amount of money.
The economy runs well when inflation is sitting around 2-3%. Inflation in Australia is currently 7-8%. This is rapidly reducing our purchasing power. To combat inflation the Reserve Bank of Australia would increase interest rates. This has the impact of taking money out of the economy and reducing demand. This provides a natural cooling to inflation.
The role of the Reserve Bank of Australia (RBA)
And that leads us to the role of the RBA! The RBA is Australia’s central bank, and its main job is to maintain a stable financial system. They do this by setting the official cash rate, which is the interest rate that banks use when lending money to each other.
When the RBA changes the official cash rate, it usually has a flow-on effect on our home loan rate. The RBA has lifted rates from 0.1% to 3.6% in the last 12 months – that hurts!
So, let’s look at a real example of how this impacts the average Aussie. The average home loan in Australia is $560,000. How does all this affect someone with a mortgage of $560,000? Let’s say that a year ago, they had a fixed interest rate of 2.1% and were paying $2,098 per month in mortgage repayments. With the recent interest rate hikes and coming off a fixed interest rate to a variable interest rate their interest rate has increased by 3.5%, and they’re now paying $3,215 per month on a variable interest rate of 5.6%. That’s an extra $1,117 per month or $13,404 per year! Ouch!
Interest rates have gone up in Australia over the last 12 months. The key reason is due to inflation rising. Inflation has increased coming out of a period of unusually high demand for goods and services after COVID. The RBA initially reduced interest rates to 0.1% and then has since gone on a rampage of 10 successive interest rate hikes, to adjust the cash rate in Australia to 3.6%. If you have a home loan, you will undoubtedly be feeling the pinch. Speaking to a mortgage broker about your home loan will ensure you’re getting the best deal available.
It’s important to keep an eye on interest rates and your household budget. The good news is that the Australian economy is staying strong at the moment. Next year will be a little bit tougher so it’s important to ensure you have the best deal on your mortgage. A mortgage broker can help you to ensure you’re getting the best interest rate for your home loan.
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