Following is a technical update of the latest change in interest rates, however at the end I have also provided explanations of the terms mentioned, so you have a clear understanding of how everything relates in the world of interest rates.
Interest Rate Update
The decision was largely anticipated and marks the third cut in less than four months - not ruling out further rate cuts.
Phillip Lowe, Governor of the RBA, indicated that a lengthy period of low interest rates is expected so that full employment and inflation targets (2-3%) are supported over time.
Will the monetary policy have any impact when interest rates become negligible? Some experts are predicting another cut to 0.5% by the end of the year and possibly 0.25% during 2020.
Should the government be doing more? So far the treasurer has said they are relying on the tax cuts and infrastructure spend to stimulate economic growth. The government’s view is that Australia is sitting well in comparison to other advanced nations... but will it be enough? At this point only time will tell.
Reserve Bank Definitions
The monetary policy is managed by the RBA and involves setting the cash rate, which influences other economic factors such as interest rates, borrowing and lending behaviour, activity in the economy and finally the rate of inflation. Because of the monetary policy’s impact, the RBA has a duty to ensure the Australian people’s currency, employment, prosperity and welfare is stable.
This is set by the RBA and is reviewed every month. Credit providers can choose to increase or decrease their interest rates in line with the cash rate.
Interest Rate Definitions
The variable interest rate, as the name implies, varies depending on changes by credit providers. These changes are often in response to a shift in the ‘cash’ rate by the RBA.
Advantages: If the cash rate goes down then variable rates will generally go down. You can also usually make unlimited extra repayments under a variable interest rate.
Disadvantages: If the cash rate goes up then it’s likely that the variable rate will as well and in some cases credit providers may increase their rate regardless of the cash rate.
A fixed interest rate on your loan means you can lock it in for a set period, which is generally 1-5 years.
Advantages: You are safe from interest rates rises during the fixed period and the consistent repayment amounts each month allow you to more easily manage your finances.
Disadvantages: If interest rates drop you will not receive the benefit of this. Any additional repayments may also be limited and if you are ending your fixed rate period on your loan early you are likely to have to pay high fees.
A partially-fixed rate loan, or split loan, means you can divide the rate you pay into a portion that has a fixed rate and the remainder a variable rate. This type of loan is something you might consider if you want to easily manage the repayments on the fixed part of your loan, while still gaining the benefit of any falling interest rates on the variable side.
The same advantages and disadvantages apply to each side of the loan as previously mentioned.
Well now your are armed with the most important definitions that relate to interest rates.
If you are a home owner with a loan, keep track of your own interest rates, particularly if they are variable or partially-fixed. If your interest rates don't align with the recent changes you might be in a position to question your bank about why they aren't following the RBA's cash rate.
On the other hand if you are about to take out a home loan it's important to ensure you are taking on the one that suits your situation. Speaking to a mortgage broker or financial adviser is a good way to do this.
Staying informed and updated is the best way to plan ahead and manage your individual situation. If you have any questions and would like to discuss your situation please talk with us.