Why Do Interest Rates Fluctuate?

When you take out a mortgage, there is almost always the guarantee that at some point over the life of the loan your interest rate will fluctuate. Even if you’ve taken out a fixed-rate home loan, it’s only stable (like the name suggests) for a fixed period. After this time, your interest rate is subject to change.

To understand why interest rates increase and decrease, you first need to know its purpose. The interest rate is essentially the fee you’re charged for borrowing money from a lender. It’s usually in the form of a percentage of your entire loan.

Depending on the RBA cash rate, competition between lenders and the state of the economy (amongst other things), the banks will tweak their interest rates to suit the current market climate – and your mortgage will be affected either way.

It’s important to know the whys and hows of interest rate fluctuation so that you can become better prepared for how it could affect your finances.

RBA cash rate and the banks

The Reserve Bank of Australia (RBA) has a direct impact on the fluctuation of interest rates. The RBA ensures the stability of the Australian economy – and has the key responsibility of setting the official cash rate. The RBA cash rate is the percentage at which the Reserve Bank lends money to the banks (like the way borrowers pay an interest rate to take out a mortgage) and is used to safeguard the economy by offsetting inflation and exchange rates.

As inflation rises, the RBA increases the cash rate, and vice versa. As the cash rate fluctuates, so do the interest rates set by the banks. Interest rates don’t normally change when the cash rate remains stable, however competition between the banks for business will slightly alter them.

Currently, the RBA cash rate has remained stagnant, according to the summary by Trading Economics:

“The Reserve Bank of Australia left the cash rate at a record low of 1.5 percent at its December meeting, as widely expected, extending its record period of policy inaction beyond two years, amid sluggishness in inflation and a slowdown in housing market.”

Competition between the banks

Due to the competitive nature of the market and how a lender is performing, banks will alter their interest rates slightly in comparison to the cash rate. If there’s no demand for business, banks will usually offer specials and discounts to attract new clients.

Similarly, if there’s a huge spike in demand, you might find banks will adjust their lending rates accordingly to remain competitive.

Interest rates fluctuate mainly in response to market conditions. While it’s hard to predict the next interest rate fluctuations, you might be able to recognise some of the factors that could signify change.

If you’re struggling after a recent rate rise or would like to know if you could be on a better package, give us a call on (08) 9417 3399 to talk with a broker.

At Select, we make finance simple.