All organizations in the mortgage industry require a prospective borrower to fulfill their selection criteria before they will approve a home loan. Traditional lenders tend to have more stringent criteria; the non-conforming lenders are a lot more flexible, and the mortgage managers are somewhere in between.
How interest rates are determined …
The Reserve Bank of Australia (RBA) sets the official interest rate, according to how the economy is performing at the time. In its monthly meetings, the RBA considers the inflation rate and such key economic indicators as unemployment, the consumer price index (CPI), producer price index (PPI) and retail sales. After analyzing this information, the board determines whether the existing rate should be held or changed.
The RBA sets the cash rate – the rate at which banks borrow money. Banks then add their own margin – the fee you pay for the use of the money – to set their mortgage rate.
The RBA uses interest rates as a tool for controlling monetary policy. For example, if economic activity is deemed too strong, it may try to slow things by raising the official cash rate. This flows on to higher mortgage rates and so higher repayments. More money repaying the mortgage means less to spend on other things, so economic activity slows.
Interest rates on home loans …
There are two types of interest rates that apply to home loans – variable and fixed. You can choose whether you'd like a variable or fixed-interest rate, or a combination of both, depending on the type of loan product you decide on.
Variable interest rates. The majority of home loans in Australia have been taken at a variable interest rate. As the name implies, variable loan rates will fluctuate with the market and the official cash rate. Therefore, if the official cash rate increases, your loan interest rate increases and so do your repayments, and vice versa. Loans with variable interest rates tend to offer more flexibility in payment options.
Fixed interest rates. This type of interest rate allows you to fix the interest rate you borrow at for a certain period within the overall loan term. Fixed terms tend to be from one to three years, however some lenders may offer 10-15 year terms. With a fixed interest rate you have the certainty of set monthly repayments, which are not affected by changes in the official cash rate. This works in your favor when the official cash rate increases because your repayments will not increase; but you can not enjoy lower repayments when the official cash rate falls. With a fixed-interest rate, your loan provider is taking the risk on the market, which is based on their assumptions about future interest rate movements.
What's been happening in the market?
Interest rates have been decreasing for more than a decade, and for the past few years Australians have enjoyed low interest rates. January 23, 1990, the official cash rate was 17-17.5%; on July 2, 2004, it was 5.25%. As a result, household borrowings are at a record high: in June 1997, Australians owed $ 202.8 billion in housing and in May 2004, this figure has increased to $ 577.1 billion.
What Interest Rate is best for you …?
o Your loan decision should be based on a mortgage product suited to your individual needs not on a type of interest rate.
o Do not borrow so much that a rise in interest rates would leave you in trouble. Factor in possible rises so you are not left short.
o You should be able to switch between interest rates over the loan term without having to refinance.
Speak to your mortgage provider, who should also be a member of the MFAA. Under of code of practice MFAA members are encouraged to continuously improve their industry knowledge by keeping abreast of economic trends and undertaking MFAA-approved and run courses and industry seminars.
For more information on interest rates, most newspapers, television and radio news broadcasts contain information on interest rates, official cash rates and the housing market in their financial and property sections. Additional information can be found on banking and financial institution websites. You can also visit the Reserve Bank of Australia website at http://www.rba.gov.au and the Australian Bureau of Statistics website at http://www.abs.gov.au
Figures from the Australian Bureau of Statistics Website – http://www.rba.gov.au