The truth about interest rate cut: how it affects you

17 Aug The truth about interest rate cut: how it affects you

Earlier this month, the Reserve Bank of Australia (RBA) has cut the official cash rate to a historic low of 1.5% to boost economic growth. But what does that really mean for interest rate?

RBA decided to lower the cash rate to 1.5%. How will it affect the interest rate? | Photo: Dan Himbrechts

Let’s face it. Not everyone is well-versed in the financial industry so when something like “RBA cuts cash rate to an all-time low of 1.5%” comes in the news, some people don’t really know what it means. They have no idea how it affects their current interest rate. You don’t necessarily need to memorise the financial terms to understand how your home loan rates benefit from RBA cuts.

This is what this article is all about. What is the connection of the cut in cash rate to your loan interest rates? What is a cash rate? And just what in the world is RBA’s role?

What is the RBA, anyway?

RBA stands for Reserve Bank of Australia and is a statutory authority—meaning, it’s a body set up by law (see Reserve Bank Act of 1959) which is authorised to enact legislation (cut interest rate, for instance) on behalf of the relevant country or state (in this case, Australia).

RBA is Australia’s central bank. It provides banking services to some government, commercial bank and other clients, except the general public. It does not contain banking facilities so it is not considered a commercial bank.

So what does RBA do?

Say, for instance, you want a new home but you don’t have enough funds. One of the effective ways is to borrow from a commercial bank. Your commercial bank gets the money you need from the RBA. Of course, you are not the only one who wants a home, so imagine the amount of demand at this point.

RBA, then, lends money to these commercial banks and offers a rate. This is the official cash rate. One of their responsibilities is to meet every first Tuesday of the month to decide whether to raise the rate, lower it or keep it the same. Their decision is of course influenced by a wide range of factors.

How does RBA cut affect your home loan?

Banks and other lenders all over the country use the RBA’s official cash rate as the benchmark for the rates they offer. The Reserve Bank will lower the interest rate in order to stimulate growth. The interest rate is basically the cost of money so a low interest rate will reduce the cost of borrowing for you. A possible outcome is that you will have greater access to funds and will, therefore, increase your spending, which helps the economy.

Take advantage of the low interest rate.

If you have a home loan, low cash rate means you will be paying slightly less on your mortgage. If you are planning on securing a loan, now is the best time to take advantage of the low cash rate. However, not all banks pass on the full rate cut so if you wish to know if your bank did, or you may want to transfer your mortgage, you should consult your finance broker.

Source: http://www.rba.gov.au/monetary-policy/about.html