Understanding the cash rate
How it affects your borrowing power and where we’re headed in the lending market.
Key topics:
- What happened in the past few months?
- What is the role of the Reserve Bank?
- What is the cash rate and how does it relate to mortgage interest rates?
- How does this affect the housing market?
- The Pressure on the rental market
- Are you looking to get a home loan?
What happened in the past few months?
There’s just
A lot
Going on.
Annual inflation rate has been hovering around 7% in recent months, and it is expected to peak below 8% by the end of 2022.
We’re facing the inflation crisis, mostly due to:
- Logistical bottlenecks
- People want to buy stuff
Just look at the household spending statistics, you can see a 18.4% uptick through the year to July 2022. People are going out spending on services and buying clothing and footwear.
Meanwhile, things are getting more expensive. We are experiencing it in the cost of groceries, petrol and construction. Our real wages are being consumed by inflation.
The pain is real. Consumer confidence is falling. 42% Australians say that their families are ‘worse off’ financially than this time last year
That’s why the Reserve Bank is stepping up and trying to implement the mechanism to ensure that the economy doesn’t overheat.
They’ve raised the cash rate this week for the sixth time since May, shifting it from 2.35% to 2.60%.
They made it very clear that they were not going to stop raising rates until this inflation beast is tamed. Meaning, more rate hikes are on the way.
What is the role of the Reserve Bank?
The Reserve Bank exists to influence expectations. That is the most important thing to know about them.
The main goal is to “achieve a more sustainable balance of demand and supply” in the Australian economy.
With the current inflation rate way out of the 2-3% target, the RBA came out lifting the cash rate because they were losing control of the narrative.
To be fair, the Reserve Bank is doing the best they can with the tools that they do have. As we all know, they can’t plant sunflowers to make cooking oil. They can’t make boats go faster. They can only address the demand side.
Right now the key tools they rely on are:
- Raising cash rate to slow down demand
- Communicating heavily with the public
Demand has to slow down for supply to catch up, because that would bring inflation back down.
The main mechanism for slowing demand is to make it more expensive for people to spend. The cost of living crisis will cause hardship so people spend less.
The opposite happened during the pandemic when the Reserve Bank lowered the cash rate to 0.1%. There was no point in putting money in the saving accounts, therefore encouraging spending to speed up the economic recovery.
What is the cash rate and how does it relate to mortgage interest rates?
The cash rate is the interest rate set by the Reserve Bank to influence the price of borrowing/depositing money, this in turn influences the level of economic activity and inflation.
It is also the rate at which commercial banks borrow and lend funds to each other overnight, which directly affects your interest rate, as the banks can pass these costs down to their borrowers.
Raising rates make borrowing the same amount of money more expensive. This is the “tightening of financial conditions” for both households and businesses.
How does this affect the housing market?
Increasing rates will further increase loan repayments. The monthly payment for an average $500k, 25-year mortgage has increased by $687 compared to April.
It will also reduce the amount people can borrow. For a borrower who was initially able to borrow $1million in April, can now only borrow $783,925.
All of this will push property prices further down. According to Corelogic, in September, properties were sold for 1.4 per cent less on average nationally than in August.
And it’s not just about home sales, it’s about wealth building. Homeownership in Australia is one of the top ways to become rich.
30% of Aussie homeowners have NO mortgage on their house, and are sitting on hundreds of thousands of dollars of gain.
25 years ago, the typical house value nationally was just $111,500 (can you imagine??). Since that time, values have risen by an average of 6.8% per annum to the current level of $571,400.
The question will be if they want to cash in – or if they’re going to wait. According to Corelogic, prospective vendors are prepared to wait out the housing downturn, rather than try to sell under more challenging market conditions.
Houses are cheaper but a person’s borrowing capacity has lowered significantly. Meaning, more and more people are priced out of the housing market.
The pressure on the rental market
Of course, the flip side of thousands of people not being able to own a home is that they have to go rent, which pushes rental prices up.
Higher rents hit those that can least afford it the hardest.
That’s why you are seeing things like this – “Grim warning to Aussie renters as record rise set to increase”.
What else are renters supposed to do but catch whatever comes to them.
Landlords are doing great because they are able to pass off costs to renters. National rent values rose 10% in the 12 months to August – a new record high annual growth rate.
Are you thinking of buying a home?
Many people are waiting for equal opportunities to say farewell to their pesky landlords and enter the housing market.
But if people spend a lot of time thinking about buying, they might not be able to afford to buy a house by the time they’ve made a choice.
LoanStreet offers a wider range of product solutions and flexible policies to help first home buyers begin their homeownership journey.
Get in touch with us today at [email protected] and we will walk you through everything you need to do to hop onto the property ladder sooner rather than later.