How will rate hikes affect personal loans?

Much has been said about the Reserve Bank of Australia raising the cash rate potentially multiple times. And if discussions are typically reserved for home loans, you may be wondering if a rate hike will impact your personal loan?

At the time of this writing, three of the big four banks forecast interest rates to rise several times over the next few years.

Big Four Bank Forecasts: How High Will the Cash Rate Go and When?

  • ABC: hikes from June. The cash rate is expected to reach 1.25% by February 2023.
  • Westpac: start of the hikes in May. The cash rate is to reach 2.00% by May 2023.
  • NAB: start of the hikes in May. The cash rate is to reach 2.50% by August 2024.
  • ANZ: increases begin in May and reach 2.25% over the next 12 months.

So what does this mean for personal loan interest rates? Simply put, if you’re on an adjustable rate personal loan, you could be immediately affected by a rise in cash rates and pay more in loan repayments.

Cash Rate Impact on Personal Loan Interest Rates

To understand why a Reserve Bank of Australia (RBA) rate hike may mean your personal loan provider raises your interest rate, you need to know the cash rate.

The cash rate, also known as the official interest rate, is the rate set by the RBA that is charged on unsecured overnight funds – money banks and lenders lend to each other to meet their cash needs. Treasury.

The RBA can adjust the cash rate in response to economic factors, such as inflation, employment and wage growth, to keep these aspects within a healthy range. For example, annual inflation in Australia reached 5.1% in the March quarter of 2022, significantly higher than in previous years. This led experts to predict that the RBA would raise the cash rate to slow spending and keep inflation from rising too high.

But what does that have to do with your personal home improvement loan or your family vacation? Well, the cash rate is used as a reference rate for interest rates on financial products such as home loans, personal loans, savings accounts, and term deposits.

And if the cash rate increases, these financial providers are encouraged to do the same and increase the interest rates on these products.

What higher cash rates mean for your personal loan

Only customers with a variable rate personal loan will feel the immediate effects if their lender raises interest rates. And the impact of that is higher personal loan repayments.

Variable interest rates are subject to market fluctuations. This can be beneficial if the RBA plans to keep rates low, as they have consistently been since November 2010. If the cash rate drops, this should in theory mean that your personal loan repayments go down as interest is now lower. If the RBA raises the cash rate, your interest rate should follow, which will increase your outstanding loan repayments.

Customers with a fixed rate personal loan have their interest rate locked in for a fixed period, typically 1-5 years. This is one of the main advantages of a fixed rate because it can protect your budget from rate increases.

So how can you ensure that your personal loan repayments are always affordable? Borrowers can consider taking certain steps to lessen the impact of a rate hike on their loan repayments, including:

  • Ask for a lower rate – Has your financial situation improved since you first applied for a personal loan, such as a boost your credit score or a promotion at work? Consider picking up the phone and asking your lender for a lower interest rate. After all, if you don’t ask, you get nothing!
  • Make additional repayments – Reducing loan principal is one way to reduce personal loan repayments, especially if rate hikes are in the works. Be sure to check first that your lender allows additional repayments without penalty.
  • Refinance – It may be worth compare lower personal loan options against your budget to see if refinancing with a new loan may be a better fit for your financial situation. Keep in mind that refinancing can extend the term of your loan and cost you more interest over time, so talk to the lender about the loan term before applying.

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