RBA Rates Decision – April 2009

The Reserve Bank announced today that the Cash Rate would be cut by 25 basis points to 3.00%.

This decision brings rate to record lows, as Australia’s economy moves into recession, after a record period of economic growth.

The big question is will the banks be passing on any of this latest cut, as they are still claiming the costs of funds are still very high.  We expect the majors to announce their decision on what level of cut they will make by the end of the week.

 

Rate Cuts – Impact on Existing Mortgage Repayments

The current series of dramatic rate cuts on variable loans is welcome news to households managing their mortgage repayments. However, as some of our clients have realised, most lenders don’t automatically adjust repayments to reflect the lower interest rates.  Let us explain further with a time line example:

As of today and over the next week or two, all lenders should announce how much of the rate cut they are passing on and what date this interest rate will be effective by.

Example:

April 6th – Current home loan of $250,000 @ 5% principal and interest repayment with 28 years remaining:  Repayments per month are: $1,383.93

If we took a snapshot of what the breakdown of this repayment is, it would look like this:
Interest Amount = $1,041.67                                      Principal Reduction amount = $342.36

April 7th – The RBA has announced a 1% cut in the official cash rate

April 10^th – Bank A announces they are passing on 50% onto its customers (4.5%), effective from 20^th April.

April 20^th – Bank A internally reduces the variable rate to 4.5%, but doesn’t automatically reduce your repayments to the lower level instead it has authority to direct debit your repayment at the higher amount ($1,383.93).  Yet the calculation of the new (lower) interest rate will look like this $1,309.95 principal and interest repayments.

Breakdown:
Interest amount now = $937.50                 Principal amount if you paid the lower amount = $372.45

 

POSSIBLE ADVANTAGE:

The upside of this is you are paying down your mortgage faster as you will have paid interest on the lower rate of 4.5% but a higher overall repayment which means the principal of the loan would reduce by $104.17 (the difference between the higher interest 5% and the lower interest 4.5% over a standard monthly period).

And as the loan is amortising lower over the loan term, the interest is also reducing on a regular basis, due to the lower principal amount for which it is calculated against on a daily basis.

 

POSSIBLE DISADVANTAGE:

We may require these additional savings made on the interest rate cut to be put back into the household budget to improve cash flow for items or bills now, so you may not want to make the higher (Extra Principal) repayments.

That’s fine as all is not lost, you simply need to contact your lender and advise them that you wish for your repayments to be adjusted to reflect the new interest rate. Most lenders will be happy to oblige.

 

(Those people reading this should be reminded this is an opinion comment by Ben Kingsley, and should not be used when making decision about financial matters without seeking further clarification and understanding of your own personal circumstances. This article is not advice you should rely upon. I recommend you speak to one of our licensed professionals before taking any action with your financial affairs.)