In This Video:00:44 How the interest rate system works 01:49 What the banks want you to do 03:14 Should you go for fix or variable rate? Hi Daimien here from Integrity. Today we’re going to talk about whether to fix or not to fix. That is the question! So with Australian Interest Rates, right now interest rates are pretty low so people are often asking me, “Daimien, is it time to fix the interest rate?”
What we’ll cover in today’s discussion:
- How the interest rate system works
- What the bank wants you to do
- The amount of effort banks go to determine their rates
- Some important points to think about before deciding to fix or stay on a variable rate
The Banking SystemA lot of people don’t understand how the banking system works. The Reserve Bank of Australia is setup to be independent from the government and it lends money to the banks. Banks also borrow money from overseas sources like China. Banks borrow that money on a variable rate. The Government requires The Reserve Bank’s to keep inflation between 2 and 3%. If inflation is going up the reserved bank will put the interest rate up. The flow-on effect of this is that it will increase the amount of interest payable on mortgages, and so reduce the amount of money that mortgage holders have in their pocket. This, of course, applies to mortgage holders on the variable rate. When this happens, they spend less money and the economy is “de-stimulated”. If the economy shows signs of slowing, The Reserve Bank will decrease the interest rate. That, in turn, will result in mortgage holders on variable rates having more spending money which they will use to stimulate the economy.
What the Bank wants you to doThis system is fantastic, but the point of it is that the bank you are with wants you to be on a rate which makes them money. The bank prefers mortgage holders to go with a variable rate, because they can change it to make profit if the reserve bank or overseas suppliers change their rates. So if you choose to go with a fixed rate, the bank has to cover themselves in case of any changes.
How Banks Determine their RatesYou can actually work out what the banks expect to happen by the differences between the fixed and variable rate.
- Fixed rate much higher than variable ⇒ reserve bank will put their variable rate up
- Fixed rate the same or slightly higher ⇒ reserve bank will keep rates the same
- Fixed rate slightly less than variable ⇒ reserve bank will drop the variable rate