How are mortgage rates calculated?

    Mortgage rates calculator

    Last month, we talked about rising mortgage rates and what that means for both homeowners and home buyers. So, how are interest rates set? Here’s a quick guide to help you understand how it all works.

    The role of the official cash rate

    You may have heard of the ‘official cash rate’ before, and especially in relation to mortgage rate movements. 

    In short, the official cash rate (or OCR) is what banks pay the Reserve Bank if they need to borrow money. Banks add a margin to that before setting interest rates for their customers – including mortgage rates. 

    How quickly and to what extent borrowers start to feel the OCR effect depends on many factors. As this interesting note from the Reserve Bank points out, the biggest impact of OCR moves on mortgage rates takes about six months, and some banks pass on more of the change than others. And of course, if you have a mortgage with a longer fixed term, you won’t feel any change until your fixed rate expires. 

    Banks also get their money from other sources

    Besides the Reserve Bank, banks get their money from a range of sources, like wholesale markets and deposits in bank accounts. 

    In a nutshell, anyone with money in a term deposit or bank account is ‘lending’ it to the bank, and in return, the bank pays them interest. So, if a bank wants to reduce their mortgage rates, they also have to reduce deposit rates to maintain their margins. But if deposit rates get too low, customers may stop putting their money in the bank – which would prompt the bank to increase their rates again. 

    And let’s not forget about the role of uncertainty

    This flow of money between different entities, combined with not-so-predictable OCR moves, creates a certain degree of uncertainty. And that’s why longer fixed-rates are usually higher than shorter-term rates: guaranteeing an interest rate over four or five years is riskier for a lender, because anything can happen within that timeframe. And as a result, their borrowing costs may increase, eroding their margins.

    What’s your mortgage strategy?

    While mortgage rate movements are largely outside of your control, what you can do is choose a mortgage strategy and adjust it in due course. 

    If your fixed rate is due to expire soon, think about your needs and goals for the next few years. How important is repayment certainty for you? Do you plan to sell your home soon? Or would you like to make significant extra repayments without incurring a break fee? 

    Take a moment to factor in the pros and cons of different rates and mortgage structures in terms of costs and flexibility. And if you have any questions, please don’t hesitate to contact us. We can talk through the options available with your lender.

    Here to help

    As mortgage advisers, we know the market inside and out, and always keep an eye on the latest developments. Like to discuss your situation? We’re here to help. And remember: our help is only a question away – visit our website to learn more.


    Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.