Interest Rates Explained: How The Big Picture Affects Your Home-Buying Plans

31/10/2015 6:14 AM AEDT | Updated 15/07/2016 12:50 PM AEST
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If you're heading out house hunting this weekend and know exactly what you want, but don't know the first thing about interest rates, you're not alone.

To understand property prices and home loan terms is to get your head abound global market forces, Reserve Bank forecasting and the macro economic modelling that shapes a country.

And all you wanted was a dishwasher and a north-facing balcony.

Here is a refresher on house buying 101, taking into account recent rate hikes and the looming Melbourne Cup Day cash rate decision.

What are interest rates?

Put simply, University of Wollongong lecturer in banking Paul Mazzola told The Huffington Post Australia it was a rate either charged or paid for the use of money.

"You can think of interest rates as cost of money," Mazzola told HuffPost Australia.

"Anyone who borrows will pay interest and anyone who deposits receives interest as income."

Why do they go up and down?

"It's simply a function of supply and demand for money in the financial system," Mazzola said.

"If they increase the cash rate, that will encourage people to deposit and drain cash out of the system, so conversely if they decrease the cash rate, people will borrow."

Who is 'they'?

The Reserve Bank of Australia -- but as Mazzola said, they don't set interest rates, they influence them.

bank

"The Reserve Bank of Australia establishes a cash rate target to manage the supply of money.

"They're not setting the interest rate -- they're setting the target at which they are willing to pay and borrow with the other banks."

What does Melbourne Cup Day have to do with interest rates?

The short answer, Mazzola said, was 'nothing'.

"Once a month on a Tuesday, the board of the RBA meets and decides whether to increase, decrease or leave the cash rate as it is.

"It coincides with Melbourne Cup because it's also on a Tuesday but there's no reason for the rate to move just because it's Melbourne Cup Day.

"It entirely depends on the economic cycle."

horse race

Why have Australia's four major banks increased their interest rates recently?

This is to do with new regulatory changes requiring banks to hold more capital against mortgages, to cushion for potential losses in the event that property prices dropped.

Mazzola said it has been spurred by the Australian Prudential Regulation Authority.

"APRA is the supervisor of the banking sector," Mazzola said.

"They're trying to improve the soundness of the financial system and one category of banks' loan portfolios they've identified as being riskier than the banks think is home loans.

"By lifting the levels of capital against an asset, it becomes less risky."

Why are there different rates for investors and owner-occupiers?

University of Technology Sydney associate professor Gordon Menzies said it came down to risk.

"Owner occupiers are supposed to be less risky clients so banks charge them a bit less," Menzies said.

What's a housing bubble and are we in one?

Australia's largest independent valuing firm Heron Todd White chairman Gavin Hulcombe told The Huffington Post Australia the bubble described a market that had gone up but was about to come down.

"It's where there is a perception that the market is overpriced and like a bubble getting bigger, is likely to burst, with values to drop," Hulcombe said.

housing bubble

"It's always a fairly emotive comment, and I think the reality is there's always a desire to adopt a blanket approach, but I'd rather look at markets within markets.

"There is an argument to say some areas overheated and could constitute a bubble, but not generally."

What is the spring buying season and why are more houses sold then?

Hulcombe said there was no hard-and-fast economic reason behind it.

"It's become self-fulfilling," Hulcombe said.

"Initially, I think it was a slightly more popular time to sell your house but the reality is now, people see it as a time when more supply is coming on, so buyers might want to wait to see if they have more options.

"Also, a lot properties present a lot better in spring when the gardens are green, and there's a perception it will get a better price."

Where's the best place to buy?

Hulcombe said that while regions rose and fell, one of the constant drivers was location, location, location.

"Proximity to major cities can generally account for higher capital growth," Hulcombe said.

"Also as Australia's capital cities tend to have traffic problems, being close to public transport is a big plus."

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