The ins and outs of interest rates

If you’re looking to buy your first home or you’ve taken the plunge and done it, you’ll be well acquainted with interest rates and their changeable natures. What you might not know is how and why interest rates change (and, no, it’s not just to be a thorn in your side).

Necessary evil

Interest rates are part of the delicate ecosystem that makes up our economy. They help control inflation in the good times and encourage economic growth in the bad times.

“Rising interest rate policy is designed to moderate strong economic activity where price growth – inflation – is increasing beyond acceptable levels. This is done by reducing demand in the economy – by making borrowing costs higher. Falling interest rate policy aims to stimulate weak economic activity by increasing demand through lower borrowing costs,” explains Dr Andrew Wilson, senior economist for Domain Group.

The rise and fall

So who sets these powerful little percentages? Don’t worry, it’s not a little chap in a green visor with an abacus; it’s the Reserve Bank of Australia (RBA). The Reserve Bank Board meets 11 times a year to decide whether interest rates rise, fall or remain steady.

Basically, the monetary policy of the RBA sets to maintain the equilibrium of the Australian economy. Interest rates, which affect mortgage rates for home lending, fall under this umbrella. The official cash rate – which is the interest rate the RBA charges on overnight loans to other commercial banks – is altered according to internal matters such as employment levels, economic growth, wage growth, inflation and the housing market, among other things. International factors, such as global interest rate moves, export prices and demand, also influence it.

“Typically, bank mortgage rates for home lending rise and fall as a response to rises and falls by the official cash rate set by the Reserve Bank each month. Both variable and fixed mortgage rates are essentially determined by the level of the official cash rate,” Wilson says.

Those fluctuating figures that are part of your mortgage are more than meets the eye – they are part of a system that helps gauge and maintain the health of our economy in the face of good times and bad.