How does the RBA cash rate affect your home loan?

Ever wondered how decisions regarding your home loan are made? Perhaps you've noticed your interest rate – and therefore your repayments – have been creeping up (or down) lately. Well, there might be a reason for that, and the Reserve Bank of Australia's (RBA) cash rate could be behind it. 

The cash rate is perhaps the largest factor influencing interest rates. Indeed, the chart below shows the relationship between the cash rate and the typical variable rate on a new home loan:

The cash rate is 4.35% right now 

See also: 2025 interest rate forecast

So, what is the RBA cash rate and how does it affect your home loan? Let's dive in.

How does the RBA cash rate affect home loan interest rates?

The Reserve Bank of Australia (RBA) uses the cash rate as a key lever to control inflation. It works by increasing or reducing the amount of money circulating in the economy – essentially the money available in the pockets of Australian consumers and businesses.

But how does the cash rate influence how much money is floating around? It does so by indirectly influencing interest rates on loans, including mortgages. 

The cash rate determines how much banks must pay to borrow money

The first step in explaining how the cash rate impacts your home loan is to explain how the cash rate affects banks' cost of doing business. Here's a simplified explanation:

By law, banks must hold a certain percentage of their assets in cash at the end of each business day. For example, if a bank has $1 billion in assets – like mortgages, outstanding loans, or securities – it may need to hold $200 million in cash reserves.

This ensures that the bank has enough liquidity to meet customer demands, such as withdrawals. But what happens if, say, 200 customers each withdraw $1 million on the same day? The bank would need to find another $200 million by the end of the day to meet its reserve requirements.

In such cases, the bank would typically borrow this money from another bank overnight. The interest it pays on those borrowed funds is determined by the RBA's cash rate. Therefore, a higher cash rate means higher costs for banks and a lower cash rate means lower costs.

What happens to interest rates when the cash rate rises

When the cash rate is low, banks can borrow money more cheaply. To stay competitive, they often pass their savings on to mortgage consumers by offering lower home loan interest rates.

What happens to interest rates when the cash rate is cut

Conversely, when the cash rate rises, banks face higher borrowing costs. To maintain their profit margins, they typically increase home loan rates, meaning borrowers pay more in interest.

Calculate how a cash rate hike or cut could influence your home loan repayments: Mortgage Repayment Calculator

How do interest rates influence inflation?

Generally, inflation increases when people and businesses have more money than they need, allowing them to spend freely – often paying higher prices for goods and services. In turn, businesses may raise their prices to match the higher demand.

When inflation is too high, the Reserve Bank of Australia (RBA) steps in to cool things down. By increasing the cash rate, the RBA makes it more expensive for people and businesses to borrow money, which reduces disposable income and curbs spending. This helps to slow down inflation.

Conversely, if inflation is too low, the RBA may lower the cash rate to encourage borrowing and spending. This puts more money in the hands of consumers and businesses, stimulating economic activity.

Ultimately, banks and lenders are behind rate changes

While changes to the cash rate can impact banks' bottom lines, banks and lenders have ultimate control over how much interest they charge home loan borrowers.

If they wish to bolster their bottom line or face higher costs elsewhere, they can increase their mortgage interest rates. If they want to be more competitive in the market, they can drop their home loan rates.

Banks and lenders might even offer cashback deals or other incentives when jostling for a larger share of the mortgage market.

Can the cash rate affect your ability to get a home loan?

Rising interest rates don't just impact people with existing loans or mortgages - they can also limit how much new borrowers are able to borrow or even disqualify some from borrowing altogether.

This is because banks must follow strict serviceability laws. In simple terms, Australian banks must ensure a borrower can comfortably repay their debts, even if interest rates were to rise.

To assess this, banks apply a mandated 'serviceability buffer', which checks whether the borrower could afford repayments if rates increased by a certain margin – typically 3% above the current loan rate.

So, when the cash rate is high, serviceability tests become tougher to pass. This can reduce the amount a borrower qualifies for or make it harder for them to meet the bank's lending criteria, particularly if they already have other financial commitments.

Of course, the opposite is true as well. When the cash rate is low, a homebuyer will likely be able to take out a larger mortgage than they may have been eligible for previously.

How you can protect your home loan interest rate from a shifting cash rate

Whether you find yourself in a low or a high rate environment, it's important to be considerate of your home loan and its interest rate. That way, you can prepare for changes that might come.

That might mean keeping abreast of advertised home loan interest rates. After all, you want to know if the rate you're paying is the best available to you.

It also likely means assessing whether a fixed or variable rate is the best option for you and your mortgage.

Fixed or variable home loan interest rates

A fixed home loan interest rate is one that doesn't change for a set period of time, while a variable home loan interest rate can shift and change.

Typically, if you think the cash rate is going to fall, you'll probably want a variable rate, that way you can take advantage of rate cuts.

On the other hand, if you think the cash rate will rise, a fixed rate might be for you, as fixing your rate could protect your finances from rate hikes.

Split rate home loans

You could also choose to separate your home loan into two portions, each with a different interest rate type. This is often called a split home loan and is offered by most home loan lenders.

A split rate can offer both stability and flexibility, since the fixed portion will be charged the same rate while the variable portion could see its rate change.

What to do if your home loan interest rate has increased

If you've just received word of a home loan rate hike, or perhaps you've been battling higher rates for some time, now might be the time to consider refinancing.

Refinancing means to move your home loan from one product or lender to another, and can result in you receiving a more competitive mortgage product.

If you're in the market for a refinancing home loan, check out some of the lowest rate options available now in the table below:

Important Information and Comparison Rate Warning

_{Image courtesy of the RBA}