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Mortgages and the Reserve Bank
Mortgages and the Reserve Bank
Mortgages and the Reserve BankThe Reserve Bank of Australia (RBA) is the central bank of the nation of Australia. The RBA is responsible for controlling the cost of borrowing in Australia. The cost of borrowing is called the "cash rate" Down Under and the Reserve Bank board meets once a month to decide what the rate should be.
The cash rate is effectively the interest rate at which banks, building societies, and other lenders borrow money. These institutions will subsequent lend the money to home owners, businesses etc at a margin. It follows then, that movements in the cash rate can impact interest rates on mortgages.
This means that the Reserve Bank is an important institution in the eyes of home owners. If the RBA decides to increase the cash rate in a particular month then home owners with variable rate mortgages will have to pay more for their mortgage every month thereafter, or until the cash rate decreases.
Before the RBA was set up, monetary policy was still set by the Federal Government. However in 1945 the Chifley government established the central bank. It was then called the Commonwealth Bank. Some years later, in 1959, the Reserve Bank was separated out from the Commonwealth Bank and monetary policy was shifted out of government hands.
Later, the government would take some control back from the RBA by setting inflationary targets. The government now endorses a range of inflation targets for the Reserve Bank to achieve. If the rate of inflation falls outside of the targetted range the central bank must write to the government to explain why.
Setting the cash rate is one of the main triggers available to the RBA when trying to keep infaltion within its target range. If inflation is too high, the cash rate will increase and the cost of borrowing money will become more expensive. This, in theory, will discourage people from spending too much money and should subsequently bring the rate of inflation back down. The opposite is true if the rate of inflation falls below the target range.
The cash rate is usually increased or decreased in increments of one quarter of a percent. This is also known as twenty five basis points. Predicting whether the RBA will change the rate in a given month is not as easy as analysing the headline inflation rate. The board will take into account other factors such as underlying trends in the things that influence inflation. Sometimes the board will decide that the inflation rate will correct itself in the coming months without any intervention from the RBA.
Why is all this important to mortgage holders?
When taking out a mortgage it is wise to factor in potential interest rate rises. If the cash rate increases and you have a variable mortgage, your monthly repayments will also increase. During times of high inflation you should be extra cautious when applying for a variable rate mortgage as the RBA is highly likely to increase the cost of borrowing in the near future. If inflation is running away quickly from the target range, several cash rate increases might be needed to bring it back down.