How will rate hikes affect personal loans?

There’s been much talk of the Reserve Bank of Australia hiking the cash rate potentially multiple times. And while discussions are typically reserved for home loans, you may be wondering if a rate hike will impact your personal loan?

At the time of writing, three out of the four big banks have forecast that interest rates will increase a number of times over the next few years.

Big four bank forecasts: how high will the cash rate go and when?

• CBA: hikes to start in June. Cash rate to reach 1.25% by February 2023.
• Westpac: hikes to start in May. Cash rate to reach 2.00% by May 2023.
• NAB: hikes to start in May. Cash rate to reach 2.50% by August 2024.
• ANZ: hikes to start in May and reach 2.25% over the next 12 months.

So, what does this mean for personal loan interest rates? Put simply, if you are on a variable rate personal loan, you may be immediately affected by a cash rate hike and pay more in loan repayments.

How the cash rate impacts personal loan interest rates

To understand why a rate hike from the Reserve Bank of Australia (RBA) may mean your personal loan provider increases your interest rate, you’ll need to know what the cash rate is.

The cash rate, also called the official interest rate, is the rate set by the RBA that is charged on unsecured overnight funds – the money banks and lenders lend one another to meet their cash needs.

The RBA may adjust the cash rate in response to economic factors, such as inflation, employment, and wage growth, to keep these aspects in a healthy range. For example, annual inflation in Australia reached 5.1% in the March 2022 quarter – much higher than the previous years. This resulted in experts predicting the RBA would increase the cash rate to slow down spending and prevent inflation from growing too high.

But what does this have to do with your personal loan for your home renovation or family holiday? Well, the cash rate is used as a benchmark rate for interest rates on financial products like home loans, personal loans, savings accounts, and term deposits.

And if the cash rate increases, these financial providers are encouraged to move similarly and hike interest rates on these products.

What a cash rate hike means for your personal loan

Only customers on a variable personal loan rate will feel immediate effects if their lender increases interest rates. And the impact of this is higher personal loan repayments.

Variable interest rates are subject to market fluctuation. This can be beneficial if the RBA is forecast to keep rates low, as they have historically been since November 2010. If the cash rate cuts this, in theory, should mean your personal loan repayments reduce as the interest is now lower. If the RBA lifts the cash rate, your interest rate should follow, making your ongoing loan repayments higher.

Customers on a fixed rate personal loan have their interest rate locked in for a fixed period, typically 1-5 years. This is one of the main benefits of a fixed rate as it can protect your budget from rate increases.

So, how can you ensure your personal loan repayments are still affordable? There are some steps borrowers can consider taking to reduce the impact of a rate hike on their loan repayments, including:

• Ask for a lower rate – Have your financial circumstances have improved since you first applied for your personal loan, such as a boost to your credit score or a promotion at work? Consider picking up the phone and asking your lender for a lower interest rate. After all, if you don’t ask, you don’t get!
• Make extra repayments – Chipping away at the loan principal is one way to keep personal loan repayments down – especially if rate hikes are on their way. Be sure to check that your lender allows extra repayments without penalty first.
• Refinance – It may be worth comparing lower personal loan options against your budget to see if refinancing to a new loan may better suit your financial situation. Keep in mind that refinancing may extend your loan term and cost you more in interest over time regardless, so talk to the lender about the loan term before you apply.

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