There has been much talk of the Reserve Bank of Australia potentially raising interest rates several times. And while discussions are usually reserved for home loans, you might be wondering if a rate hike will affect your home loan?

At the time of going to press, three out of four big banks forecast that interest rates will rise many times over in the next few years.

Forecasts of the Big Four banks: How high will the cash price be and when?

• CBA: Hikes begin in June. Cash rate to reach 1.25% by February 2023.
• Westpac: Hikes begin in May. Cash rate to reach 2.00% by May 2023.
• SNAP: Hikes begin in May. Cash rate to reach 2.50% by August 2024.
• NO: Rate hikes start in May and reach 2.25% over the next 12 months.

So what does this mean for interest rates on personal loans? Simply put, if you have an adjustable rate personal loan, you may be hit immediately by a rate hike and pay more to pay back the loan.

How cash interest affects personal loan interest rates

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

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

The RBA can adjust the cash rate in response to economic factors such as inflation, employment and wage growth to keep these aspects within healthy ranges. For example, annual inflation in Australia reached 5.1% in the March quarter of 2022 – much higher than in previous years. This led to pundits predicting the RBA would raise interest rates to curb spending and prevent inflation from getting too high.

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

And when cash rates rise, these financial providers are encouraged to do the same, raising interest rates on these products.

What a cash interest rate hike means for your personal loan

Only customers with an adjustable rate loan will feel an immediate impact if their lender raises interest rates. And the result is higher personal loan repayments.

Variable interest rates are subject to market fluctuations. This may be beneficial if the RBA is expected to keep interest rates low, as it has historically since November 2010. In theory, if the federal funds rate goes down, it should mean that your personal loan repayments go down since interest rates are now lower. If the RBA raises interest rates, your interest rate should follow, causing your ongoing loan payments to increase.

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

So how can you ensure your personal loan repayments are still affordable? There are some steps borrowers can consider to reduce the impact of a rate hike on their loan repayments, including:

• Ask for a lower price – Have your financial circumstances improved since you first applied for your personal loan, e.g increase your credit rating or a promotion at work? Consider picking up the phone and asking your lender for a lower interest rate. Because if you don’t ask, you get nothing!
• make special repayments – Staking away the principal of the loan is one way to keep personal loan repayments low — especially when rate hikes are imminent. Make sure your lender allows additional repayments without penalty first.
• refinancing – It can be worth it Compare lower personal loan options Compare it to your budget to see if refinancing into a new loan better suits your financial situation. Remember that refinancing can extend your loan life and cost you more interest over time, so talk to the lender about the loan life before applying.

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