Across Australia, there’s always a lot of interest in interest. The regular meetings held by the RBA to set interest rates are met with speculation in the lead up and – once the decision is made – analysis about the causes and impacts of any decision.
These RBA meetings set the ‘cash rate’. But, as every borrower, saver and credit-card user knows, this is very different to the interest rates most people see.
What is the cash rate?
It might be a surprise to many, but banks regularly lend each other money. There are lots of reasons for this, such as managing day-to-day cash flow and always having a set amount of cash available, which is required by government regulation.
The cash rate – also called the overnight bank rate or the base interest rate – is the amount of interest banks charge each other on these bank-to-bank loans.
But why is there a difference between this rate and regular loan interest rates?
Interest rates – the basics
In simple terms, this is how banks and other financial institutions see money:
- Banks take in deposits (savings) from individuals and businesses. By law, they then have to pay interest to those savers. This is called a ‘funding cost’.
- The banks then use this money to lend out to people wanting access to extra money they haven’t saved. This money might be used to expand a business, pay for a jet ski or buy a house. The bank then charges interest on these loans, known as the ‘lending rate’.
So many different rates
This all comes down to two things:
- Risk: banks assess the risk of a borrower failing to be able to repay the loan
- Profit: Banks need to remain profitable for their shareholders, and for the stability of the whole system. The global financial crisis of a decade ago was caused in large part by bad loans not being repaid.
When a borrower applies for a loan or a credit card, banks assess things like income and credit history to decide whether to lend the money. The interest rate they charge represents the overall risk of approved borrowers defaulting on their loan.
Lenders know that they’re more likely to lose money from a credit card loan than from a home loan (jet skis and Uber Eats don’t hold their value, while property often increases) so interest on credit cards is higher. The risk of another bank being unable to pay a loan is very slim. And that’s why the RBA cash rate is lower than your home loan or credit card rate.
Worried about your rate?
If you’re hoping to purchase a place to live – or struggling to make repayments on your current loan –we can help you secure a home loan that will suit your financial situation. Living with financial stress is no fun, so we make every effort to understand your real-estate dreams while also helping you understand the costs of any loan.
Talk to our expert home loan brokers at Mortgage Broker Melbourne. Our service is always free for you, although lenders may charge fees for any loan you take out.
Marc has been a professional lender for 28 years. After beginning his career in 1990 with a UK Building Society, he moved to Australia where he held several different retail banking roles. In 1999 it became clear to him that a mortgage broker would eventually become an obvious choice for someone looking for a home loan so he took the plunge and became an independent broker. He hasn’t looked back since!