What Do Interest Rate Cuts Mean For You?

On 3 June, the Reserve Bank cut the interest rate to a historical low of 1.25%. It was the RBA’s first cut since 2016 and some economists are predicting more cuts to come.

Assuming banks pass on the cut to their clients, this should be positive news for Australians with a mortgage. If you’re already in debt, one good strategy might be to continue making repayments at the higher rate to reduce the principal debt. It might also be a good time to borrow for investment: AMP reported the doubling of borrower activity with Lendi in the day after the cut was announced.

Bank Lending

The AMP also reported the suggestion that if the interest rate drops even further, banks will be less interested in lending. Of course, the flip side of a rate cut is that lower interest rates on loans means lower interest on investments, which affects retirees particularly.

While some see the cut as flagging trouble in the economy, there might be some bright spots in the gloom.

For example, the Australian Prudential Regulation Authority (APRA ) is making changes, including removing the 7% serviceability buffer on home loans and raising the second buffer against the interest rate paid by the borrower by 0.5%.

How It Affects Borrowing Capacity?

This change would bring a buffer of 6.5% – which would increase the borrowing capacity of the average person by 11%. If the buffer fell to 6%, people’s borrowing capacity rises to 20%. At that rate, people previously wanting a $500,000 loan could afford a $600,000 loan.

What could that extra $100,000 achieve for a borrower? They might buy a home in a higher price bracket. Perhaps some of that potential value could be spent on furniture and appliances in that higher-bracket home. Some could become an investment loan.

It’s true that the average Australian household is already heavily in debt, although a recent Finder.com.au article notes that the majority of Australian personal debt is “good” debt, taken on to build long term wealth, through real estate or investments.

Taking on an extra $100,000 in debt while rates are low may still be a risk, but that may be mitigated if it’s taken on with wealth creation in mind.