How does the RBA cash rate affect your home loan?
The cash rate potentially holds more influence over your home loan than anything else. Here’s how.
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:
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.
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 is cut
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 rises
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:
| Lender | Interest Rate | Comparison Rate* | |||||||
|---|---|---|---|---|---|---|---|---|---|
| 5.29% p.a. | 5.33% p.a. | Owner OccupierVariablePrincipal & Interest10% Min DepositRedrawExtra Repayments | Available for purchase or refinance, min 10% deposit needed to qualify.No application, ongoing monthly or annual fees.Dedicated loan specialist throughout the loan application. | More details | Compare | Promoted | Disclosure | ||
| 5.24% p.a. | 5.15% p.a. | Built and funded by CommBankOwner OccupierVariablePrincipal & Interest20% Min DepositRedraw | A low-rate variable home loan from a 100% online lender.Backed by the Commonwealth Bank. | More details | Compare | Disclosure | |||
| 5.39% p.a. | 5.43% p.a. | Owner OccupierVariablePrincipal & Interest10% Min DepositOffsetRedrawExtra Repayments | Available for purchase or refinance, min 10% deposit needed to qualify.No application, ongoing monthly or annual fees.Quick and easy online application process. | More details | Compare | Promoted | Disclosure |
Important Information and Comparison Rate Warning
Image courtesy of the RBA
Collections:RBACash RatesInterest Rates
How to buy land with a vacant land loan
Published on 29 Oct 2024
Dreaming of building your own home from the ground up? You might consider turning to a land loan to purchase your perfect block.ON THIS PAGEWhat is a vacant land loan?Why buy vacant land instead of an established home?How large of a deposit do you need for a vacant land loan?How to compare vacant land loansWhat do lenders consider when approving land loans?Transitioning from a land loan to a construction loan
Found the perfect block of land but not quite ready to build your dream home? Or maybe you’re looking to secure the land now while you take your time to plan ahead.
If you opt for a house and land package, typically funded by a construction loan, you’ll need to start building soon after you settle. But what if you want to lock in your land now and hold off on breaking ground? In that case, a land loan – also known as a vacant land loan – might be the perfect solution.
What is a vacant land loan?
Land loan
A land loan is a home loan product designed for those purchasing a block of land without immediate or definite plans to build on it. Such a buyer might be planning to build on the land in the future, aiming to subdivide it, or hoping to make a capital gain by selling it later on. Often, lenders provide land buyers with a standard mortgage, even if it’s labelled a ‘land loan’. Typically, the loan is secured against the land itself.
Land loan vs construction loan: What’s the difference?
While they might sound like similar products, land loans and construction loans differ markedly.
- Vacant land loan
Sees a lender provide funds for purchasing undeveloped land. The borrower repays the loan amount, along with interest, through regular instalments, just like a standard home loan. - Construction loan
Sees a lender release funds in stages to cover the costs of building or major renovations on a property. The borrower only pays interest on the funds that have been drawn down at each stage of construction. Once construction is complete, the loan typically converts to principal and interest repayments.
Why buy vacant land instead of an established home?
Purchasing vacant land can offer unique advantages over buying an established home depending on your financial goals and lifestyle preferences. After all, owning land now means you can build on it in the future, subdivide it, or make a capital gain by selling it later on. Here are a few reasons why buying vacant land can be more advantageous than purchasing a standing dwelling:
1. Less stamp duty
- You’ll likely pay less stamp duty when buying a block of land than you would buying an established home. That’s because the amount of stamp duty payable is based on the land’s value alone (rather than a home’s combined land and property value).
2. Potential to save
- Buying land could allow you to secure a plot in your ideal location while still giving you time to save for building. Buying property is expensive, and splitting your purchasing into two – the land and the build – could provide more financial flexibility.
3. Location
- Purchasing land could see you buying in an area you want to live, even if homes there aren’t currently available or affordable. By securing the block first, you can establish roots in your preferred location and build your dream home when you’re ready. In the meantime, the value of that land could increase, potentially providing equity.
4. Customisation
- Buying land on which you plan to build gives you control over the design and layout of your future home, making it easier to create a property that meets your needs, preferences, and lifestyle.
Drawbacks to buying land instead of an established house
There are also downsides to buying land rather than an established dwelling. You’ll need to cover construction and infrastructure costs and the longer timeline to build means you won’t be able to move in immediately. Location can also be a limitation, as vacant land is often farther from established amenities and you mightn’t have the same range of choices you would if you were buying an existing home.
See also: Should you build or buy a house?
How large of a deposit do you need for a vacant land loan?
The size of the deposit you’ll need in order to take out a land loan will vary depending on how much you’re spending to buy the land, whether you’re willing to pay for Lenders Mortgage Insurance (LMI), and the policies of the lender you choose. Generally, you’ll need a deposit of between 5% and 20% of the land’s value.
That means that if you’re looking to spend $400,000 on your vacant land purchase, you’ll likely need a deposit of $20,000 to $80,000. Lenders tend to demand borrowers who have deposits of less than 20% pay for LMI, which can total thousands of dollars. While some lenders might accept prospective buyers with deposits as small as 5%, others will ask that a larger sum is handed over.
The amount you need for a deposit might also depend on the land you’re purchasing. For rural blocks, particularly large or small plots, or land with significant easements, lenders may ask for a larger deposit. This is because such properties pose a higher risk; if you default on the loan, the lender mightn’t be able to sell the land quickly or for its original purchase price.
How to compare vacant land loans
If you are all set in applying for a land loan, start your search for the best lender and loan offer that will fit your needs. A mortgage broker can help you but these are some of the things you need to look for when searching for a land loan:
Interest rate
You might find that land loans tend to have higher advertised rates than other home loans due to the risks associated with land purchases. Though, lenders often provide traditional mortgages for land purchases, which would likely see a borrower paying a ‘normal’ interest rate.
Make sure you also consider the comparison rate, which gives an estimate of the overall cost of the loan.
Fees
Be sure to ask your lender to break down the costs associated with your land loan, including any fees.
Deposit
Depending on the size of your chosen land, you can borrow as much as 95% of its value. Remember, however, that you might have to pay LMI if your deposit is less than 20% of your land’s value.
Features
As with home loans, lenders can provide you with useful features for your land loan to help you pay it faster. These features include additional payments, flexible terms, and offset and redraw facilities.
What do lenders consider when approving land loans?
Lenders will consider certain aspects of the land you’re purchasing when reviewing your land loan application:
Land size
Lenders have different policies regarding land size; some require a larger deposit for unusually large or small plots, and some may cap the size they’re willing to finance.
Zoning and land registration
Part of the lender’s assessment process includes reviewing the access and zoning regulations for the vacant land you wish to purchase. Generally, the land must be zoned for residential use to qualify for a land loan, as residential zoning reduces the lender’s risk. The land might also need to be registered, meaning it is connected to essential services like roads, electricity, and has received official registration approval from local authorities.
While some developers sell unregistered land, lenders are often hesitant to finance its purchase because it lacks infrastructure or may face regulatory delays.
Planned use and building approvals
Lenders may want to know your intended use for the land, especially if you’re not planning to build immediately. While specific building approvals may not be necessary for a land loan, demonstrating that the land has future development potential can reassure lenders.
Transitioning from a land loan to a construction loan
If you purchase a vacant plot now with a land loan and later decide to build, you’ll likely need to convert your land loan into a construction loan to finance the building process. Since construction loans typically require the building works to be completed within a set timeframe, it’s important that you only apply when you’re nearly ready to break ground. Here’s how the process of transforming your land loan into a construction loan might work:
1. Notify your lender of your plans
- The best place to start is likely informing your lender about your plan to build. It’ll guide you on the process to either add a construction loan on top of your land loan, or convert the land loan into a construction loan.
- Though, some lenders don’t provide construction loans, in which case you could refinance your land loan to a new lender or turn to another lender for a separate construction loan.
2. Secure building plans and approvals
- Most lenders need detailed building plans, a fixed-price building contract, and council or regulatory approvals before dishing out any funds via a construction loan. The building contract will outline the cost and stages of the construction, which the lender uses to schedule payments.
3. Reassessment and new loan terms
- If your lender is willing to transition your land loan to a construction loan, it will likely also reassess your financial situation. It may conduct a new valuation to determine the combined value of the land and completed property, and might count any equity you hold in the land as part or all of your deposit.
- If approved, the construction loan will typically be paid in addition to the land loan or replace the land loan, and new terms will apply. That means you may have to reapply or refinance under new terms.
4. Set up a drawdown schedule
- Unlike a traditional loan, a construction loan disburses funds in stages. The lender releases funds in increments aligned with each stage of construction.
- You’ll likely only pay interest on the amount drawn down at a given time, which helps reduce interest costs during construction.
5. Transition to principal and interest repayments
- Once construction is complete, the construction loan will transform into a standard home loan and you’ll begin making regular principal and interest or interest only repayments.
Article originally written by Gerv Tacadena in 2022. Last updated by Brooke Cooper in 2024.
Image by wirestock on freepik
Collections:Home Loan Basics Guides & ArticlesCompare home loan rates from 4.64%
Use our comparison tool to find a home loan that best suits your needs.compare home loan rates
Compare Home Loans
Compare home loansRefinance home loansFixed home loan ratesOwner occupied home loansVariable home loan ratesGreen home loansNon-bank lenders
Related Guides
Guide to Switching Home Loans
Thinking about switching your home loan to snag a better deal? You’re not alone.
