The US economy is one of the biggest markets in the world. A shift in its policies, particularly in interest rates, creates a ripple effect on the entire world.

When the US suffered from a financial crisis in 2008, the Federal government had to cut interest rates to 0-0.25 %. The government maintained this until the year 2015 after which they slowly raised the rates back up. 

Then the pandemic happened in 2020 and industries had to close down. The Fed had to cut the rate back to the 2008 level once again.

In February 2022, the US government revealed that for the first time since 1982, the inflation rate in the country is at its highest of 7.5%. This is triggered by the rising costs of food and energy, further exacerbated by the problems brought by the Covid-19 pandemic. 

The ongoing war Russia has waged on Ukraine is not helping either. Russia is one of the biggest oil exporters in the world and the conflict has raised the price of oil significantly. When oil prices are high, the cost of production rises, too, consequently affecting all industries.

What is inflation and how do interest rates affect this?

In cases of crippling inflation rates, the government’s step is to raise interest rates. Raising interest rates means consumers have to pay more when they take out a loan from banks. This discourages loans and puts a halt to the ballooning of the money supply. This then triggers the cooling down of the economy. 

Conversely, when the economy is sluggish, the move of the government is to cut interest rates. This means the cost of borrowing money is smaller and encourages more personal and business loans and gets the economy moving again. 

Governments do the best they can to regulate inflation with the goal of maintaining healthy employment rates and price stability. 

Will Australia follow suit?

Again, the rise in interest rates in the US is not an isolated case and will never be. The Bank of England has also raised its interest rates for the first time in three years to 0.25%, with the expectation of bringing it back to the pre-pandemic level of 0.75%. Other banks all over the world have followed suit including South Korea, Brazil, and New Zealand among others. 

Australia is likely to follow suit. AMP Capital chief economist Shane Oliver, Australians should expect to see the official cash rate at 0.25% in June. This is the first for this year out of the three expected hikes that will lead to the target of a 0.75% official cash rate.

What does this mean for you as a home buyer?

If you have a loan right now and the official cash rate increases, the interest rate you will be paying is going to be higher. It’s as simple as that, really. 

A hike in the official cash rate means all banks are going to follow along. Even when the RBA cut the official cash rate to nearly zero to stimulate the economy, some banks still went on to increase their rates. 

Although the rate change you have to shoulder usually just comes down to a small fraction, when computed against your whole loan amount, it could lead to a significant increase in your monthly loan repayment. 

In early 2022, Westpac raised its fixed term rates. If you took out a loan of $500,000 in a fixed 5 year term, payable in 30 years, a 0.2% increase in interest rate means you have to pay $56 more every month. That is an additional payment of almost $700 every year. 

What can you do about this?

Since the interest rate hike is not a surprise, there is one thing you can do to cushion yourself from the impending effects. 

Consider switching to a fixed interest rate. In the Covid era, fixed-rate loans were at 2.34%. It has insistently risen over months to 2.43% for loans under a fixed term of 3 years.  If you lock in your loan now, the interest you will be paying is at 3%. The pre-determined period for this could be up to 5 years.

 Although there is no telling where the rates will stand after such a period, you can rest assured that you will be paying the same amount for the next 5 years, safely guarded against the three rate hikes coming up. 

Major banks and small lenders have been raising their rates in the past months. You can still enjoy lower rates if you act fast now. As you race against time, the more you delay the decision, the higher the interest rates you will be getting. 

Talk to your broker now for the best options you can make to enjoy peace of mind in the coming years.