Adulting: Fixed and Variable Interest Rates

In shopping around for a loan, so far we’ve looked at interest rates and comparison rates. Now we’re going to look at variable and fixed interest rates. Seems quite obvious doesn’t it? A fixed interest rate stays the same amount for the term stipulated on a loan (usually 5 years) and a variable rate can go up and down.

Interest rates, especially variable interest rates are not exclusively determined by the bank providing the loan. It’s the Reserve Bank of Australia (RBA) that plays the biggest role in determining interest rates nationwide for one of their primary goals is to keep Australia’s economic welfare stable; there is a set target that they must achieve and maintain. When determining an interest the RBA looks at the activity over the previous month of overnight loans and the interest rate of those overnight loans in the money market; this is the cash rate. The RBA board meets on the first Tuesday of every month (except January) to determine the cash rate. Their decision is effective from the next day.

So, to keep the cash rate where it needs to be sometimes the RBA dishes out money to the banks like “Here, have all the money, we have too much!” and the banks respond by going “Hey, we don’t need that much money. Hey, Sheeples! We’ve got some money you might want. We’re almost giving it away”. And if the RBA is tightening the belt they’re like “No banks, bugger all money for you!” The banks’ response is “If the RBA won’t give us the money, we’re gonna take it from the Sheeples through higher interest rates!” This behaviour correlates directly back to those overnight loans and the cash rate target mentioned before.

Want to learn more about the RBA? Check it out here.

A fixed rate can change if the bank feels inclined to pass an interest rate drop onto its borrowers but your repayments don’t change and overall you’re protected from an interest rate increase though there are certain options that might not be available to you. Variable rates however, you’re at the mercy of the bank and your repayment amounts can vary according to the interest rate. Banks often offer more flexible terms for variable rate borrowers, however, the uncertainty of knowing what your repayments will be can make budgeting difficult.

Once again, shop around, find the deal that’s right for you and your situation. And as boring is at may seem, pay attention to what the news says about decisions made by the Reserve Bank of Australia. Once you’ve got a loan it affects you! Especially if you’ve chosen a loan with a variable interest rate.