Difference between official cash rate and mortgage interest rate
When discussions about the cash rate and interest rates come up, novice homebuyers may be left scratching their heads. These concepts sound complicated but they’re not as hard to understand as they seem. Knowing about the cash rate and its impact on current home loan interest rates can even help you make better-informed decisions as you navigate the world of real estate.
In this article, we explain what the cash rate is and how it affects mortgage interest rates.
Cash rate: What is it and how does it work?
The cash rate set by the Reserve Bank of Australia (RBA) refers to the market interest rate commercial banks charge for overnight loans. It’s sometimes called the bank rate, base interest rate, or overnight money market interest rate.
It goes like this: commercial banks borrow money from each other to meet daily cash needs. An interest rate is charged during these transactions. Simply put, the interest rate from these overnight loans is the cash rate. Take note, the cash rate is not the same as a mortgage interest rate. The cash rate may influence the interest rate a lender will set on their loan products.
The RBA changes the cash rate to coincide with the changing demands of the Australian economy. The RBA’s goal is to stabilise the Australian currency and support the country’s economy. Factors that the RBA takes into consideration when changing the cash rate include employment, inflation, growth, business and consumer confidence, and the international economy.
The members of the RBA board meet to discuss cash rate changes on the first Tuesday of every month (excluding January). They can choose to retain the current cash rate, move it up, or move it down.
Cash rate vs mortgage interest rate: What’s the difference?
As we said previously, the cash rate and mortgage interest rates are entirely different things. The RBA cash rate is the benchmark on which banks may base their products’ interest rates including the current interest rates on home loans. Meanwhile, a mortgage interest rate is the interest borrowers pay on their home loans. The mortgage interest rate is determined by the lender based on several factors which may or may not include the cash rate.
The mortgage interest rate can change depending on the type of loan, as well. Home loans can have a fixed interest rate where the rate stays the same until the end of the fixed term or a variable interest rate where the rate can fluctuate throughout the life of the loan.
| Cash Rate | Mortgage Interest Rate |
|---|---|
| The rate is determined by the Reserve Bank of Australia (RBA). | The rate is determined by the lender and depends on the type of loan taken out, amongst other factors. |
| Rate changes are influenced by local and international economic factors. | Rate changes could be influenced by the cash rate but do not solely rely on it. |
| Rate changes are made to support the Australian economy. | Rate changes are made in line with the lender’s funding costs, competition, and risk of default. |
| The cash rate is paid from bank to bank on overnight money market loans. |
The mortgage interest rate is paid by the borrower to the lender on house loans. |
How does the cash rate affect mortgage interest rates?
Mortgage interest rates aren’t directly impacted by changes to the cash rate. There may be circumstances where a lender will increase or decrease their interest rates following any changes in the RBA cash rate. However, a lender may also change their interest rates for many other reasons, for example, when there are changes in the costs of funding.
You will notice that when the cash rate is high, the interest rates lenders are offering on their loans are likely to be high; whereas when the cash rate is lower, the interest rates lenders are offering will likely be lower. You may also notice similar rate fluctuations if you already have a variable-rate loan. Those with a fixed-rate loan, however, will not have any changes to their interest rate during their fixed term, regardless of any fluctuations in the cash rate or lenders' interest rates.
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