With the interest rate on your home loan directly influencing your monthly repayments, it’s important for you to understand just what shapes this rate so that you aren’t stuck with a home loan with a high interest rate.

It used to be relatively simple, lenders would simply follow what the Reserve Bank of Australia (RBA) was doing to the cash rate, i.e. if the RBA cut the cash rate by 25 basis points, lenders would follow by reducing their standard variable rate (SVR) by 25 basis points and vice versa if the cash rate increased.

This is no longer the case, in the last decade, lenders have increasing changed their SVR independent of what the RBA is doing.  And because of this, tracking the cost of housing finance has become a little more complicated.

So, what exactly influences your lender’s interest rates?

The regulatory body

The RBA is Australia’s central bank. As an independent body, the RBA’s primary role is to ensure the country’s prosperity and to manage economic growth, including by controlling inflation.

As part of this role, the Bank’s board members meet every month to set an official cash rate, based on a range of local and global economic factors. The board’s decision is announced on the first Tuesday of each month.

The cash rate influences domestic economic activity and therefore inflation. This is because that influence affects financial instruments such as government bonds and deposits, which in turn affect interest rates within the broader economy.

While RBA movements still has a somewhat effect on lenders’ rates, these days, other factors – such as cost to the bank of obtaining funds and maintaining their net interest margin are of more importance to your lender.

Other influences

To provide a home loan, a lender must secure funds from other lenders, both locally and internationally. This is referred to as wholesale funding.

In the aftermath of the global financial crisis and subsequent European debt crisis, the availability and cost of securing funds had increased dramatically, giving lenders an opportunity to cite funding cost and move away from wholly tracking RBA’s cash rate movements.

This prompted many lenders to set their interest rates in line with these costs rather than in response to the RBA’s rate decisions.

At that time, this change was justified by the Senate Economics Reference Committee, which concluded, “The Reserve Bank’s policy rate is only one influence on banks’ cost of funds. It is therefore not reasonable to expect that banks’ variable interest rates on housing loans should always move in parallel with changes in the Reserve Bank’s policy rate.”

Following this statement, the Reserve Bank itself re-emphasised this point by announcing:

“In Australia, most deposits and loans are at variable or short-term fixed rates, so there is a high pass-through of changes in the cash rate to deposit and lending rates. But because of other factors influencing capital market rates and fluctuations in the level of competition in the banking sector, deposit and lending rates do not always move in lockstep with the cash rate.”

While a strong banking system is essential to maintaining economic stability, the ever-increasing profit announcements by the banks tell us that our banks are not only successfully keeping their funding cost low, their net interest margins are healthier than ever.

In a report released in April 2020, the ACCC stated that on average an existing mortgage borrower can save $5,000 per year by refinancing to a new lender.

What does this mean for you, with a highly competitive mortgage market there is a better home loan options available which will potentially save you thousands of dollars.

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This article does not constitute advice; readers should seek independent and personalised counsel from a trusted adviser that specialises in property, a tax accountant and property design specialist.