Consumers are widely expecting a rate cut to be announced when the reserve bank meets tomorrow for their monthly meeting.As at Monday, 5 December, 2011, the official cash rate is sitting at 4.50%. Home loan rates however sit comfortably around 250 points (2.5%) above that figure.
A change in the official cash rate will usually result in a change in home loan rates… but not always by the same amount.
We thought it would be a good idea to explain why there is a difference… and also what drives that difference. MyRate reviews and tracks the spread between the official cash rate and mortgage rates regularly – and the difference between the two is driven by various factors.
Prior to the Global Financial Crisis (GFC), if the RBA moved rates, home loan rates would have moved by the exact same amount. This was true for at least the decade preceding the GFC in 2007. This same period also saw the big four banks advertise the same interest rate for their standard variable home loans. This was because the world financial markets were extremely stable and funding costs of banks were pretty much closely tied to the official cash rate as a reference rate.
At the onset of the GFC, this stable environment changed, and all of a sudden the cost of funds for lenders had to price in risk.Without over complicating the details, this basically meant that before overseas investors would give the banks money to be used to fund Australian residential home loans, they would want to know about the lending practices of the banks, their profile of borrowers, what the likelihood of getting paid back were, etc.
This resulted in a paradigm shift where the margin added to the official cash rate that determined the net cost of wholesale funds, blew out dramatically. So much so that changes in the official cash rate as a reference rate almost became insignificant compared to the changes being priced in daily for the various risks mentioned above.
With the current crisis in Europe, those same overseas investors are once again getting nervous and are again demanding a bigger return on their money they are lending Australian banks to fund home loans. As a result, the cost of funds for Australian institutions is diverging from changes to the official cash rate.
What does this mean for Australian borrowers? Well, basically, we should not expect RBA official cash rate movements to result in similar movement to home loan rates. This is the current situation and it looks likely to remain this way until some global financial stability returns.
The MyRate Team
