Interest Rates will Bite

The recent 0.25% increase in the cash rate will likely be the first of many rises.  Higher interest rates are a warning to businesses that rely on discretionary consumer spending.

 

What has happened?

At the May 2022 board meeting, the Reserve Bank of Australia (“RBA”) announced that it was increasing the cash rate for the first time since November 2010, taking it from 0.1% to 0.35%.

The cash rate is the figure set by the RBA, representing the interest that banks and lenders have to pay on money that they borrow.  The RBA takes a number of factors into consideration when setting the cash rate, such as inflation, economic growth and the level of employment.

What are the banks going to do?

While banks and lenders are not obliged to follow the decisions of the RBA, it will mostly likely form part of their decision-making when setting their own interest rates. Namely, when the cash rate is low, banks and lenders may be expected to offer lower interest rates to new buyers and refinancers.  In the present circumstances, a rise in the cash rate means that home loan interest rates increase, with lenders passing the costs onto the borrowers.

Three of the Big Four banks announced on 3 May 2022 that they will passed this rise onto their customers.  For example, CBA has announced that effective as of 20 May 2022, it will be increasing their home loan variable interest rates by 0.25% per annum, with ANZ and Westpac announcing similar changes.

What does this mean for borrowers?

Generally speaking, the rise in the cash rate means that the average owner-occupier with a $500,000 debt and 25 years remaining on their mortgage will see repayments rise by around $65 per month.

Chief Officer of Consumer and Business Banking for Westpac, Chris de Bruin, has stated that “We know many of our customers were able to build up their savings during the pandemic and 70 per cent of home loan customers are ahead on their repayments, helping put them in a better position to withstand an interest rate rise.”

However, since the increase was announced, many have raised the question of why does the RBA raise rates and increase many people’s cost of living, when the cost of living is also on the rise?  In simple terms, raising interest rates makes borrowing money more expensive, meaning that for people with a mortgage, their repayments are higher. However, this can also lead to more returns on savings and superannuation, which accrue interest on growth.

In turn, when borrowing becomes more expensive, the demand for goods and services become less, intending to bring prices down.

This is an important warning sign for business that generate their revenue from discretionary consumer spending.

It is also relevant to the housing market, noting that in the past 2 years, Australia’s property prices increased by as much as 26%.  Following the rise in the cash rate, AMP Capital’s Chief Economist Dr Shane Oliver says he expects house prices to fall up to 15% over the next two years.

However, it is highly likely that the rate rise will add to the cost pressures facing households with a mortgage, with some bank customers never likely to have experienced a rate rise of this significance.  As a result, many of the banks who have announced increased interest rates have urged customers to seek support if they are struggling financially following the changes.

It remains to be seen, whether further increases in the cash rate may lead to rising numbers of personal insolvency for existing borrowers. However, with further rises anticipated, borrowers who have not prepared for such circumstances may find themselves at risk.

Based on a 30-year principal and interest loan with an initial 2.5% interest rate, please see below a table that outlines potential home loan repayments should interest rates rise further:

 

Home loan principle 0.25%

increase

0.40% increase 0.50% increase 1% increase 1.5% increase 2% increase
$250,000 $33 $53 $66 $135 $206 $279
$500,000 $65 $105 $132 $269 $411 $557
$750,000 $99 $159 $199 $405 $618 $837
$1,000,000 $131 $211 $265 $539 $823 $1,116
$1,250,000 $164 $264 $331 $674 $1,029 $1,395
$1,500,000 $197 $316 $397 $809 $1,234 $1,673
$2,000,000 $263 $423 $530 $1,079 $1,646 $2,232

 

 

 

0

Like This