How Do Rising Interest Rates Impact Your Borrowing Capacity?

Rising interest rates have struck again in 2022. For the second time in 35 days, the RBA has raised the interest rate, throwing homeowners and potential buyers alike into a frenzy. This rate means current mortgage repayments are about to increase, which may come as a shock, especially for recent first home buyers. After dealing with a hot property market over the past few years, those looking to buy their first home are now being forced to re-evaluate their loan applications as their borrowing power is impacted. So, how do rising interest rates impact your borrowing capacity? Here is everything you need to know.

What is the cash rate rise, and how does it impact interest rates?

In Australia, our monetary policy is controlled by the Reserve Bank of Australia (RBA) and is dependent on factors such as employment, inflation, economic growth, consumers, and the housing market.

Cash rate

The cash rate, set by the RBA, differs from interest rates which lenders set. The cash rate represents the interest that banks and lenders have to pay on the money they borrow. Canstar explains this by simply saying: “Over the course of doing business, banks transfer money back and forth between each other, and the cash rate is the interest paid on this money.” What once was held at a record low of 0.10 per cent in November 2020 (due to the effects of the pandemic), has increased due to inflation. This inflation has been caused by numerous factors, such as COVID-related disruptions to supply chains and the war in Ukraine. In May 2022, the cash rate increased to 0.35 per cent. In June 2022, the cash rate target increased to 0.85 per cent.

Interest rates

Banks and lenders set their own interest rates and often base these on the cash rate. When the RBA raises the cash rate, it costs the banks more to transfer money back and forth. Banks and lenders will typically pass these costs onto consumers in the form of rate rises, meaning anyone who has borrowed money from that institution will be charged more interest. The four big banks – Westpac, CBA, ANZ and NAB – all responded to the rate rise in May by passing on the cash rate rise in full to their customers. So far, Westpac is the first to respond to the recent decision to increase the cash rate, increasing their home loan variable interest rates by 50 basis points per annum. 

How do rising interest rates impact your borrowing capacity?

Unfortunately, with cash rate increases impacting interest rates, consumers take the hit with increases to their current loans and their potential borrowing capacity. Although every situation is unique, Inovayt Commercial Finance Broker Melbourne Marty Vidakovic provides an example of how this can affect your borrowing capacity. In this scenario, he uses the following factors:

• Two adults earning $80,000 p.a. each
• One child
• $4,400 general living expenses
• $10,000 credit card limit.

“Prior to the latest rate rise, this family would be able to borrow $980,000,” says Marty. “After the rates increased, the same family would be able to borrow $935,000 – a significant difference of $45,000 in borrowing capacity.” “Every time rates increase by 0.50 per cent; your borrowing capacity drops by $40-45k (based on the above numbers). However, your borrowing capacity can change from lender to lender depending on their internal criteria, which is why it’s important that you talk to your broker.” What does this mean for prospective buyers? Whether it’s for your first home or your next home, prospective buyers have been thrown into disarray with rising interest rates. In recent analytics, home prices in Australia’s capital cities have slowed down at the most rapid pace since 1989. When the first price hike was announced in May, the rate of home price growth slowed from 24 per cent to 14 per cent, which saw house prices fall. Despite the market slowing down, house prices aren’t necessarily going to decrease. “The question is, will the property market drop as significantly as your borrowing capacity?” Marty says, “History tells us – no!” How will current homeowners be affected? For homeowners on an already tight budget, it’s about to get a little tighter. Monthly mortgage repayments on variable loans will increase based on the size of your loan. Homeowners are also feeling the pinch from the rising cost of living due to soaring petrol prices and grocery prices reaching an 11-year high. The increase in these costs is mainly related to supplier pressures, labour shortages, extreme weather events, border closures and the knock-on effects of the pandemic and the Ukrainian war. The cash rate rise is the RBA’s way to help mitigate inflation. Unfortunately, the cost of living isn’t expected to decrease for a while still. For homeowners, mortgage repayments will look a little different for everyone. However, the following figures can be used as a rough guide.

• A loan of $550k would see an increase of $132 per month.
• A loan of $600k would see an increase of $160 per month.
• A loan of $700k would see an increase of $186 per month.
• A loan of $800k would see an increase of $214 per month.
• A loan of $900k would see an increase of $241 per month.
• A loan of $1M would see an increase of $267 per month.

I’m worried – what should I do? Although there are many uncertainties now, keeping on top of your budget and eliminating unnecessary spending will benefit you and your family. If you regularly revisit your budget, consider looking at it a little earlier than usual after the most recent announcements. Cut out any subscriptions and streaming services you no longer use and consider comparing the price of groceries between the major supermarkets to find the best price. With the cost of living and interest rates rising, we’re living in very uncertain times. Checking in with your mortgage broker or financial advisor will help you assess how these rises will impact your budget and mortgage repayments and how you can best manage your money. Get in touch with one of our brokers today for advice tailored to your situation.