What Are Interest Rates And How Do They Affect You?
For most people, interest rates are important because they determine how much interest they will pay on their home or investment loans. For anyone looking to buy or thinking of investing in property, current interest rates and their future movement (either up, down or remaining stable) will also have an impact on their decision-making and their long term strategies. In this guide to interest rates we provide a simple explanation of rates as well as whether people looking at investing in property should consider fixed interest or variable mortgages.
Despite popular belief, interest rates are not set or influenced by the Government, but rather set by Australia’s central bank, the Reserve Bank Of Australia (RBA). The RBA defines interest rates as the “cost of borrowing money or the return to the owner of the funds which are invested or lent out[i].” Every month the Board of the RBA meets to decide what the “cash rate” should be for the following month, after looking at a range of important factors such as economic growth, inflation (the rate at which the level of prices for services and goods is rising), building and construction figures and employment.
They are essentially “taking the pulse” of Australia’s economy to see if levels of growth are in line with expectations, or whether they may need to stimulate the economy with lower rates. The Board can also decide to keep interest rates steady, or raise them if they believe inflation is getting out of hand (the higher the rates, the less people borrow money and this will in turn slow the economy).
Once they have announced their decision, the banks and other lenders will decide whether to pass on either a rate cut or increase their interest rates for borrowers. Again, despite popular belief, they are not obliged to simply match the RBA’s cash rate – they have their own set of complicated factors to consider such as the cost of the funding they receive from international wholesale capital markets.
Fixed Interest Versus Variable Home Loans
When interest rates are low for any period of time – as they have been for the past few years at the record rate of 2.5% – it is tempting to opt for a fixed interest home loan when investing in property. A fixed rate is one that you agree to with your bank or lender, and you are normally “locked” into that rate for either 1, 3 or 5 years. Because you know your costs, this can be a great way for you to be able to plan strategically and stick with a budget. It can also mean that you do not have to worry or change your plans if the rates do start to increase.
On the other hand, while choosing a variable home loan rate can mean that your costs may increase if the banks and other lenders decide to increase their rates in the future, a variable loan also may allow you to make extra payments on your mortgage, meaning that you can pay down the amount sooner. Keep in mind that many banks also allow you to fix part of your mortgage (say 50%) while making the other part variable, giving you the best of both worlds. Whatever you decide, choosing how you want to pay off your mortgage and the flexibility you will need should be an important part of your property investment strategy.