Rate Change Calculator

What Is The Interest Rate?

An interest rate is the cost of borrowing money, expressed as a percentage of the principal loan amount.

• For borrowers, it’s the price paid over time for using funds.
• For lenders, it’s the return received for allowing others to use their capital.

Naturally, changes in interest rates influence borrowing and spending. Higher interest rates discourage borrowing, reducing spending. This means homeownership takes a hit as borrowers don’t want to get a loan at a higher rate.

Similarly, lower rates encourage borrowing, stimulating spending and potentially boosting economic activity. Lower interest rates affect the real-estate market, as they can nudge people into buying homes and investment properties.

Therefore, interest rates are crucial for controlling inflation and managing economic growth. They change periodically, often influenced by the Reserve Bank of Australia (RBA).

The RBA adjusts its cash rate – the rate banks charge when lending to one another – to influence interest rates, maintain price stability and promote sustainable economic activity, reacting to evolving economic conditions. When the cash rate goes up, interest rates tend to go up. When the cash rate goes down, interest rates tend to go down.

What Happens When Interest Rates Increase?

When interest rates increase, borrowing becomes more expensive.

This leads to reduced consumer spending and business investment, as loans for houses and cars become pricier.

In the case of mortgages, when the RBA raises interest rates, mortgages become more expensive.

This affects Australian homeowners and potential homebuyers, as monthly repayments rise. Potential buyers may get discouraged amidst higher interest rates. Demand decreases.

Also, investors may sell properties, further affecting supply. Increased mortgage stress can lead to reduced consumer spending, affecting the broader economy.

What Happens When Interest Rates Decrease?

When interest rates decrease, borrowing becomes cheaper. This encourages increased consumer spending and business investment, as loans become more affordable.

So, when the RBA lowers interest rates, mortgages become more affordable. This stimulates demand in the Australian housing market, potentially driving up property prices.

First-home buyers and investors are more likely to enter the market. Increased borrowing power can lead to higher housing debt.

How Is An Interest-Rate Change Calculated?

Let’s say the RBA decides to cut the interest rate by 25 basis points.

Scenario

A homeowner has a $500,000 variable-rate mortgage with 25 years remaining on it. Its current interest rate is 6%.

The RBA decreases the cash rate by 0.25 percentage points (25 basis points), leading their lender to reduce their mortgage rate to 5.75%.

Calculations

• Original Monthly Repayment (6%): The monthly repayment is about $3222.
• New Monthly Repayment (5.75%): With the new rate, the monthly repayment is about $3146.
• Monthly Savings: $3222 – $3146= $76.
• Over a year, the savings are $76 x 12 = $912.
• Over 25 years, the savings will be $22,800 considering the interest rate remains static.

Furthermore, a smaller interest rate means more of the monthly payment is going to the principal of the loan, so the loan will be paid off faster.

Possible Outcomes Of Interest Rate Changes

Different scenarios can play out when interest rates change. Here’s the rundown:

Scenario 1: Rate Increases, Lenders Pass On Rate Change

When interest rates increase, mortgage repayments rise, affecting household budgets and forcing a reduction in discretionary spending. Cooling housing demand, resulting from higher costs, may lead to a gradual or rapid decline in property values. Lenders may see increased interest revenue, though higher rates can also reduce borrowing demand and affect loan repayment rates.

Scenario 2: Rate Increases, Lenders Don’t Pass On Rate Change

When the rate increases and lenders don’t follow through, they absorb the increased funding costs without passing them on. This ensures the borrowers continue to pay the same mortgage amounts as they maintain their spending habit. The intended economic slowdown, aimed at curbing inflation, is delayed or weakened due to sustained consumer activity.

Scenario 3: Rate Decreases, Lenders Pass On Rate Change

If lenders pass on rate cuts, mortgage repayments may decrease, potentially freeing up disposable income and encouraging spending among homeowners. A surge in housing demand driven by lower borrowing costs can lead to a rapid increase in property values. Lenders typically see an increase in new loan approvals as lower rates attract more borrowers seeking new mortgages or refinancing.

Scenario 4: Rate Decreases, Lenders Don’t Pass On Rate Change

When the RBA lowers the cash rate and lenders don’t follow suit, borrowers do not benefit from reduced repayments, hindering the intended increase in consumer spending and economic activity. Lenders maintain higher profit margins, capitalising on the difference between the central bank rate and their lending rates. The economic stimulus intended is less effective, as the intended increase in spending is suppressed.

Conclusion

Interest rates, although usually seemingly small percentages, can put a hole in both your wallet and the wider economy.

Whether it’s the RBA making adjustments or lenders passing on the changes (or not), it is clear that these moves affect your mortgage.

With our rate change calculator, you can get a detailed breakdown of how your repayment can change when interest rates do.

Stay updated on RBA rate cut decisions and monitor their potential impact on your mortgage repayments. And if you’re ever unsure, don’t hesitate to reach out for a free assessment.