Why interest rates are rising

Interest rate rises are expected to put more pressure on household budgets during 2022.

The Reserve Bank of Australia (RBA) began lifting its cash rate in May from a historic low of 0.1% by 0.25% to 0.35% – the first rise in 11 years.

This was followed by consecutive rises of 0.5% in June and July, taking the rate to 1.35%.

Borrowers whose banks passed these rises on in full would have seen their repayments on a $500,000 mortgage increase by about $311 per month* since the May rise.

The Reserve Bank is raising rates to stem significant increases in Australia’s inflation rate which plays an important role in ensuring our economy is stabilised through controlling its money supply.

After announcing the July rise, Reserve Bank Governor Philip Lowe said monetary policy globally was responding to high inflation and it would be some time before inflation returned to target levels in most countries.

“Inflation in Australia is also high, but not as high as it is in many other countries,” Mr Lowe said.

“Global factors account for much of the increase in inflation in Australia, but domestic factors are also playing a role.

“Strong demand, a tight labour market and capacity constraints in some sectors are contributing to the upward pressure on prices. The floods are also affecting some prices."

Mr Lowe forecast inflation to peak later this year and then decline back towards the 2–3% target range next year.

“As global supply-side problems continue to ease and commodity prices stabilise, even if at a high level, inflation is expected to moderate,” he said.

“Higher interest rates will also help establish a more sustainable balance between the demand for and the supply of goods and services.”

Mr Lowe indicated further interest rises were likely in coming months.

“The board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead,” he said.

“The size and timing of future interest rate increases will be guided by the incoming data and the board's assessment of the outlook for inflation and the labour market.

"The board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”

Banks, including RACQ Bank, factor in the potential of significant interest rate rises when assessing home loan applications to ensure the borrower can meet increased repayments.

In October last year, the Australian Prudential Regulation Authority (APRA) increased the minimum interest rate buffer it expected banks to use when assessing the serviceability of home loan applications.

Lenders were advised to assess a borrower’s capacity to service a loan at least 3% higher than the product rate, up from a 2.5% buffer.

This buffer is used to assess whether a borrower could repay the loan not at the rate provided on the day, instead taking into consideration whether they could repay the loan if the rate were to increase by 3%.

APRA made the move in anticipation of interest rate rises.

Borrowers with a variable rate home loan will have seen increases in their loan repayments in the days after the Reserve Bank announcements.

Those with a fixed rate home loan won’t see an increase until the end of their current term.

Click here to learn more about variable and fixed home loan rates.

RACQ Group Executive Banking Michelle Winzer said she understood the impact of interest rises on mortgage holders.

“We know two-thirds of our home loan members are ahead on their repayments, putting them in a better position to manage an interest rate rise,” Ms Winzer said.

“However, we understand these interest rate rises may be challenging for some members.

“We encourage anyone who believes they may experience financial hardship to give us a call and we can talk through their options.”

“We are here to support our members as some may not have experienced interest rate increases since they took out their loans.”

Interest rate rises are better news for those with savings accounts.

“We know many of our members took care to build up their funds through the pandemic, however they were unable to place them into products with rates which returned an impactful profit, creating difficulty in growing their savings,” Ms Winzer said.

“Interest rate rises will see them get a better return on their savings and investments.”

What can you do to safeguard against home loan rate rises?

• Work out what the repayments on your loan would be if the interest rate increased by up to 3%. Setting yourself up now by making fortnightly repayments and paying more than the minimum will mean you have a bigger buffer as rates rise. Adjusting spending now means higher rates won’t catch you out. RACQ’s home loan repayment calculator can help you determine how much your repayment would be if interest rates rise.
• Ensure you're getting the most from your savings to build up a savings safety buffer. There are various savings account options to choose from which will suit different savings styles.
• Consider fixing your rate or splitting your home loan into part variable and part fixed rates to safeguard against any potential rate rises. This gives you the flexibility to repay a certain amount of your loan quicker while having a part of it fixed to ensure repayments do not increase during the fixed rate period.
• Work out a budget and pay any surplus funds into an offset account or directly onto your loan. Before making extra repayments, check if your loan has a redraw option which will allow you to access the extra loan repayments you have made if needed. This is only applicable for variable loans.
• If you don’t already have an offset account, ask your lender if it’s an option for your home loan. This can be an easy way to reduce the overall interest paid on your loan and still ensure cash is available should you need to access it quickly. Treat this money as something you can’t access, so you don’t spend it unnecessarily.

More information on RACQ Bank’s loan and savings products can be found here.

*Calculation based on monthly repayments for a loan of $500,000 taken over 25 years and the interest rate rising 1.25% from 1.69% to 2.94%.

Banking and Loan products issued by Members Banking Group Limited ABN 83 087 651 054 AFSL/Australian credit licence 241195 trading as RACQ Bank. Fees, charges, terms and conditions apply. Contact us for a copy. 

The information in this article has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained in the document is general advice and does not take into account any person's particular investment objectives, financial situation or needs. Before acting on anything based on this advice you should consider its appropriateness to you, having regard to your objectives, financial situations and needs.