The RBA has raised the cash rate for the first time in 12 years and that’s big news. The cash rate went up by 0.25% in May 2022 and is currently sitting at 0.35%. Hopefully it means higher term deposit rates, but for those with property, it also means higher home loan rates.
The prediction is that mortgage rates will increase by 2.00% over the next couple of years, which will add $192 more per week in repayments to a $500,000 loan.
What happened?
The RBA has increased the Cash Rate Target (“the Cash Rate”) to 0.35%. The RBA Governor Philip Lowe said that over the next 2 years, he expects a series of rates rises, with the Cash Rate likely to be closer to 2.50%, and that borrowers should use this in their benchmark in cashflow budgeting.
How does this translate for borrowers?
The Cash Rate is linked to the Australian financial system and it impacts deposits, and as a result, loans. If the Cash Rate increases to 2.50%, banks are likely to increase deposit rates to close to 2.50% p.a. The banks will then use deposits to help fund their home loans. Given banks want to make a profit, the home loan rate will always be higher than the RBA cash rate. That means if the RBA raises rates to 2.50%, perhaps the variable rate will be closer to 4%.
Increasing home loan rates will impact your borrowing power
Did you know that the banks are required to add a buffer of 3.00% p.a. to the current home loan rate when calculating what loan you can afford?
Let’s say you have a 4.00% home loan rate in 2023 if the RBA cash rate continues to rise. The bank will add this 3.00% to the 4.00% and use a rate of 7.00% to calculate what you can afford. This means people won’t be able to borrow as much compared to when the assessible loan rate was 6% or lower.
Rising rates is not a reason to panic
It is worth keeping in mind that banks have been calculating borrower’s capacity to repay loans at 5.00%+ p.a. for several years now. So, if people keep their jobs, many can continue to afford the mortgage repayments, although they may need to reduce a few luxuries from the monthly budget.
Who is most affected from the rate rise?
While everyone with a mortgage is affecteed, those who have purchased in the last 12 months may especially feel the pinch. Approximately 286,000 home sales occurred in the last 12 months out of the 8,900,000 private residences across Australia (source: realestate.com.au). This means that most existing homeowners are sitting on increased equity in their homes as prices have gone up in recent years across Australia. This acts as a buffer for losing any real equity in their homes (source: 2016 Census) .
That means if house prices do come off 10% to 15%, it gives a lower entry price for first home buyers and growing families who need more space.
Why is this interest rate rise happening now?
Inflation is the key driver for the increases to the RBA Cash Rate as the RBA sets an inflation target of 2.00% to 3.00%. The latest report in April 2022 is 3.70%, with expectations that inflation could go above 6.00% in 2022. But that said, much of the inflation we have been experiencing has been structural in nature.
Below are some examples of the structural causes of the inflation within our economy:
- The semi-conductor shortages have reduced the supply of cars and increased the costs.
- Around the world, COVID has meant lower production of things as people have taken up to two weeks off, before going back to work. And there simply haven’t been enough workers in many industries.
- China maintains a COVID zero policy, reducing the number of workers available to build things for the world markets.
- A carrier ship with thousands of new cars, bound for Australia, recently sunk. Across almost all brands you will wait between 4 months to 12 months for a new car, and dealers are ratchetting up prices for existing stock.
- In 2021, the North American and Brazilian forest fires meant less timber internationally, but with the same levels of demand. This will take a couple of years to recover, whilst building material prices have gone through the roof.
- The trade war with China has meant western countries are looking to source some goods elsewhere, but COVID has meant other places aren’t ready to manufacture these things.
- The war in the Ukraine has further strained supply chain issues.
- Normal demand is still there, but the supply of goods isn’t there to match.
- Retailers pass on the price rises and don’t discount at all, or even add extra for themselves. Therefore, prices go up.
All these things will take time to resolve. Between months and years. Just imagine how long it takes to create a new factory in a new country. You need to find a location, negotiate to purchase it, get plans drawn, then building approvals, then build it, fit out the building with machines, desks etc, then employ and train new workers. All the while, costs are rising here in Australia, and workers are starting to ask for pay increases to make up some ground.
Key takeaways
While inflation hangs about, the RBA will begin to raise interest rates to combat it. And with both the trade wars and military wars sticking about in the global headlines, inflation will likely be baked in for a while, so plan accordingly.
Those with mortgages or looking to buy a property will need to start to putting aside more. Despite this, we believe that many Australian households will be able to manage the increase in interest rates.
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