29 Oct Cashed Up: Everything You Need to Know About the Reserve Bank of Australia
In this week’s episode, we talk about cash and the Reserve Bank of Australia (the RBA), the official cash rate, what it does and how it affects you. We’re going to look at how the economy is going on an individual level and how the flow on effects us.
The Reserve Bank of Australia
So what is it? It’s an independent central bank to the government. They deal with the cash rate and stability of financial system. Through open market operations, all the RBA does every first Tuesday of the month is set the cash rate. They look at how well the exchange rate is going, unemployment rates etc.
What is the official cash rate for?
It’s simply the interbank lending rate – the rate the banks actually borrow money from each other. To increase the rate, they won’t print as much money, or buy money off the RBA. Then to decrease the rate they’ll increase more. It’s all supply and demand, the more money in the economy the lower the interest rate will be. To stimulate the economy they’ll lower the cash rate and to cool it down they’ll raise it to help control consumer spending and lower inflation.
Over the past five years, we’ve seen a steady decline in the rate because the economy isn’t doing so well, so the RBA is stimulating the economy to get people spending.
How does it affect home loan interest rates?
So for example, the banks borrow at 1%, they then add their own clip so an extra 2% and then will lend the money to an individual at 3%. The interest rate will go down in cycle with the RBA’s cash rate.
The banks still set their own interest rates and that’s called an out of cycle interest rate. It’s an excuse to make extra money and margin; they don’t need to follow the cash rate. The flow on effects are nil if they don’t do so, so when the rates are down they’re advised to, otherwise the bank is making an extra margin. So all of its services are making banks more profit rather than helping the economy, it works on cash rates for term deposit. It doesn’t affect the lending side and also the deposit side.
The RBA stress test
The RBA did their own which APRA has been doing a lot too, and also is why banks are increasing investment rates.
There’s more stress on speculative when people in Sydney were buying on 1% yield – on speculation that it would increase in 12 months. They want more owner-occupied borrowers because if times get tough they’re less likely to just dump their property on the market because they live there. This is why they’re trying to slow down investment lending.
They did a stress test and found interesting things. The most interesting thing about it is that usually, the RBA doesn’t go into this level of detail.
Prices are starting to stagnate or go down a bit. That’s Brisbane and inner-city Melbourne which are cooling a bit. Sydney is stagnating and they’re also looking at other conditions in the market. Like macroeconomic scenarios, what the flow on effects of rising interest rates will be. Most people now as a household are spending less on their mortgage than 10 years ago because interest rates are lower. However, they’ve found it’s still more expensive to own a property than rent one. So there’s a divide.
They’ve also found that over time the number of investments people own has increased. 2 in 9 households have more than one property and most are using it as an ability to invest. 1 in 14 own more than three. There’s been a steady rise in the baby boomer era of individuals owning more than one property. That’s what they’re trying to stop, a bubble of people buying too much property.
If you’re investing in a property, do the numbers on worst case scenario and assume it will be vacant 2 – 3 weeks, that the rental growth might not change and make sure you can ride it out.
Through lower interest rates your reduce the time of your loan too. Keep a buffer and don’t keep it too thin, if you have an extra expense you’ll get caught out.
Selecting property ratios – doing the modelling, any quick tips?
A rule of thumb is – in some areas, for every $100k worth of property you should expect about $100 worth of rent. With deposit ratios, it’s not going to be a cash flow burden if it’s an area going up in value you can go for higher leverage. It depends on what level you’re at. You might have less of a deposit to get going. But you want to build a buffer. Once you get to that level you need to be at 50 – 60% gearing for banks to lend you more money.
Some interesting things to remember are the fact that the RBA is doing it as opposed to APRA and over time if rates do go up we’re in an interest yield trap.
The key takeaway points from this episode are:
- The RBA affects you, your money in your bank account and the deposit rate.
- Before you buy, you need to do your own stress test to make sure you’re not putting yourself in a worse off position through buying an investment property.