Every time a bank increases their rate out of sync with the RBA announcement, we are asked why the bank changed the interest rate while RBA did not. In this article we discuss a few factors that influence a lender in determining their interest rate.
The Reserve Bank of Australia (RBA) sets the official cash rate, it is just one of several factors that influence mortgage interest rates. Therefore, fluctuations in the cash rate aren’t exactly mirrored by changes to variable interest rates.
Lenders incur funding costs which have an impact on the interest rates they offer borrowers. There are also credit and liquidity risks which must be considered. These factors, along with the cash rate and market competition are used to set loan interest rates.
Liquidity and funding costs
Liquidity refers to the amount of cash and assets a lender has available to pay bills and meet its short-term financial obligations. There is not enough cash in Australia for every bank and financial institution to have sufficient liquid cash at the same time, so lenders need to borrow funds overnight. This short-term borrowing is facilitated by the RBA and the official cash rate is actually the overnight money market interest rate.
The other rate which has a significant impact on lenders’ funding costs is the Bank Bill Swap Rate (BBSR). This short-term swap rate is the interest rate banks charge each other in the wholesale market. The BBSR is different to the official cash rate, although the two are closely tied and both rates fluctuate.
So, how does this affect your interest rate?
It depends on how the BBSR and official cash rate move. Both may go up or down together or separately. It all is influenced by demand and supply of money.
Rate increases
In instances where the BBSR moves up but the official cash rate remains stable, it becomes more expensive for lenders to cover the cost of their funding. Higher funding costs, means banks have to review their profit margins to ensure the interest rates they offer are viable to maintain. This is known as an out-of-cycle interest rate rise.
Similarly, when the official cash rate goes up so do funding costs. Again, lenders compensate for this by passing the costs on to their customers and interest rates are increased. Both variable and fixed interest rates will typically increase, however, existing customers with fixed rate home loans will not be affected until their fixed term expires.
Rate decreases
A decrease in the cash rate or both the BBSR and the cash rate will reduce lenders’ costs. Most lenders will reduce their interest rates to pass these savings on to their customers.
On the face of it, rate decreases are good news for borrowers, but the knock-on effects can have consequences. When interest rates drop, so does the interest accrued on savings. People who previously relied on high interest savings accounts tend to withdraw their savings to invest in other avenues which offer higher returns.
Fewer savings accounts mean less money in the bank in other words, less liquidity. Banks have to turn to the more expensive wholesale market to fill in the gaps. That said, the BBSR and official cash rate are usually closely tied so when the cash rate drops, the BBSR usually does too. But if the difference between the two rates becomes great, lenders will struggle to pass on the full cash rate decrease and remain profitable. Therefore, lenders may only decrease their new customer interest rates or only pass on a portion of the cash rate decrease to existing customers.
Lower interest rates for new customers only
Banks and non-bank lenders rely on their existing customers’ loan repayments to cushion the impact of fluctuations in the BBSR and official cash rate. This is necessary to ensure shareholder confidence and financial stability. A vulnerable bank is at risk of failing. The compromise is offering lower interest rates for new customers only.
The law requires mortgage brokers like FinKonsel to find a panel lender that best matches your needs. If you have any questions about your interest rate or would like to discuss refinancing your home loan and discover the best solution to suit your needs, please contact the FinKonsel team.
Disclaimer:
The information provided in this fact sheet is not legal, taxation or financial planning advice. It has been prepared without considering your specific needs, objectives, and personal financial situation. Before acting on this information, we recommend that you consider carefully if it is appropriate for your needs, objectives, and personal financial situation. All loan products are subject to lender criteria and approval. Lender fees, terms and conditions apply.
FinKonsel Mortgage Broking Team – finkonsel.com.au
FinKonsel is a CPA and IPA Public practise. Vivek Perti is Credit Rep # 473246 authorised under Australian Credit License 389328. His number is 0434 810 388 and email is vivek@finkonsel.com.au