How does the RBA’s interest rate rise affect you?

reserve bank of australia building

Older Australians have received mixed economic news with the Reserve Bank of Australia (RBA) announcing it was lifting official interest rates by 25 basis points to 0.35 per cent.

It was a move that many considered overdue, so it came as no surprise when RBA governor Philip Lowe announced the official cash rate would be raised to 35 basis points, up from the current 10 basis points.

The decision to finally raise the cash rate after more than a decade is good news for those drawing an income from bank savings but is a negative for anybody paying off a mortgage.

For retirees, the announcement was tempered by a government decision to freeze deeming rates for two years.

Deeming rates determine the estimated income earned on part pensioners’ financial assets, which then determines how much they receive as a pension payment.

The upper deeming rate of 2.25 per cent, which is what the government deems pensioners to have earned on their investment balances above $53,600 for singles and $89,000 for couples, will stay unchanged. The lower deeming rate for investment balances below these thresholds will also stay at 0.25 per cent.

Prime Minister Scott Morrison said the freeze would ensure retirees could deal with rising costs.

“This is another shield to help protect Australians from the cost-of-living pressures people could feel from an increase in interest rates,” he said.

“We will guarantee the rate of income for people who could otherwise see their social security income drop because of the increase in interest rates.”

Rising interest rates will put additional pressure on vulnerable Australians already struggling to survive as prices surge, says St Vincent de Paul Society national president Claire Victory, adding that the “rate rise will be another kick in the teeth for Australians living in poverty already stretching every dollar to its limit”.

“Today’s interest rate hike will add to these pressures and disproportionately impact the most vulnerable people in the community, who are already struggling to get by,” says Ms Victory.

“We are calling on parties and candidates to take urgent action in the remaining weeks of the campaign to support Australians living in, or at risk of falling into, poverty.”

The cash rate rise will be a burden for retired pensioner homeowners with a mortgage.

Raising the cash rate increases the cost of lending for the bank, which passes that increased cost to the consumer through higher monthly mortgage payments. All of the Big Four banks have announced they are passing on the rate rise.

Read: Inflation good news for older Aussies – or is it?

“It was widely expected to happen and signifies the real importance of households to review their budget,” says Matt Gatt, general manager of home loans at Compare Club.

“Although the RBA has raised rates, not all lenders are guaranteed to move in line with each other, they will still make their own assessment as to whether they pass on some, all or none of the rate rise.”

Mr Gatt says that for a mortgage of $600,000, a rate rise of 0.25 per cent (25 basis points) would, on average, increase annual interest charges by $1500 per year, or an extra $125 per month.

But many older Aussies who still have a mortgage acquired that loan many years ago. According to the RBA, older loans typically have higher interest rates than newer loans, so the rate rise will hit those customers even harder.

Mr Gatt says this provides the perfect opportunity to refinance your mortgage.

Read: Costs rising higher as petrol prices fuel big CPI increase

“Mortgage holders shouldn’t fret if they didn’t move soon enough to avoid this additional expense,” he says.

“The sooner they review, the better off they’ll be. Our expectation is in line with market expectations that rates will continue to rise over the remainder of this year and into next year.”

The news is better for those who have paid off their mortgage and are living off savings, but the positive effects might not be felt straight away.

Much like passing on the higher rate through mortgage payments, banks also have to make the decision to pass on the savings rate to customers, which they are historically slow to do.

“The history, unfortunately, is that the banks will pass on an interest-rate increase for their existing home loan borrowers,” says Steve Mickenbecker, finance executive at Canstar.

“But they don’t necessarily pass on the full interest rate increase to people they borrow from – the savers.”

Read: Time to tap into a reverse mortgage given soaring prices?

How raising interest rates can tackle inflation

With cost-of-living pressures at all-time highs and inflation hitting its highest point in more than 20 years, you could be forgiven for wondering why the RBA is choosing to raise rates right now.

It’s precisely because inflation is so high that the RBA has acted. Raising interest rates is, in fact, virtually the only tool the RBA has to combat inflation.

By raising interest rates, the RBA is attempting to lower demand within the economy.

Higher rates mean higher debt repayments and that means people have less spare money and will think twice before taking out any new loans.

This reduces overall demand for goods and services, which would usually be seen as a bad thing, except in this case.

If overall demand outstrips an economy’s capacity to supply the goods and services, then prices will rise as customers compete against one another. If prices rise, workers will begin wanting more pay to cover the increased cost of living.

If businesses need to pay more for workers, they will pass those costs on to customers and prices rise further still, leading to more wage increases.

This is known as the ‘wage-price cycle’ and the RBA is attempting to stop this cycle. It is inflicting short-pain on Australians for their long-term gain.

“It’s kind of not about what’s happening now, it’s about what’s going to happen,” says Cherelle Murphy, chief economist at EY Oceania.

“And if the Reserve Bank doesn’t get on top of inflation now and it starts to take off – and we’ve seen this, internationally, we’ve seen it in the US, we’ve seen it in the UK – we could be facing much more dire inflation.

“So the best act really is to get on with it, and to start taking that little bit of demand out of the economy to slow price growth.”

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Written by Brad Lockyer

Brad has deep knowledge of retirement income, including Age Pension and other government entitlements, as well as health, money and lifestyle issues facing older Australians. Keen interests in current affairs, politics, sport and entertainment. Digital media professional with more than 10 years experience in the industry.

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