Guide to interest rates

“Interest” is the name of a fee charged for borrowing money. Interest is typically charged as a percentage of the amount borrowed, referred to as the “interest rate”.

The interest rate on a financial product is the effective “cost” of borrowing money from the lender. The higher the interest rate, the more interest you’ll be charged on the loan or credit product.

You can also be paid interest when you deposit money with a bank or similar financial institution. This is because depositing money is effectively lending your own money to the bank, for it to use to help provide financial products and services to other customers. So, just as a lender may charge you interest on a loan, a bank may pay you interest on your savings.

Banks and lenders set their interest rates based on a wide range of criteria, from the strength of the Australian economy to the cost of overseas funding. One factor that can have a notable and significant effect on interest rates is the national cash rate, which is set by Australia’s central bank; the Reserve Bank of Australia (RBA).

The national cash rate is the interest rate on unsecured overnight loans between banks and other lenders. Banks use these overnight loans to help them access the cash needed to provide financial products and services to their customers. Because the cash rate affects the overall “cost” of money, changes to the cash rate are typically reflected in changes to interest rates on loans and deposits.

Eleven times a year, on the first Tuesday of every month except January, the RBA meets to decide whether the cash rate should go up, down or remain the same – a decision which affects millions of Australians. 

Changes to the national cash rate often lead to changes in interest rates from banks and other financial institutions. A rising cash rate often leads to increasing interest rates, and cuts to the cash rate can see interest rates fall.

Keep in mind that while changes to the cash rate can affect interest rates, it’s not the only factor in play. Banks and financial institutions have multiple funding sources, and may choose to raise or lower their interest rates out of cycle from the RBA.

Interest rates are different from the cash rate as they also cover the bank or lender’s other risk factors and costs.

Generally, the higher the financial risk to the lender, the higher the interest rate they may charge.  For example, loans that are secured by the value of an asset (such as a mortgage or a secured car loan) are more likely to have lower interest rates than unsecured loans (such as an unsecured personal loan or a credit card).

Similarly, financial products and services that come with more features and benefits (such as a home loan that offers unlimited extra repayments, free redraws, and an offset account, or a credit card with a rewards program) often charge higher interest rates than more basic “no-frills” variations.