In the last couple of years, interest rates have crept up and up.

In fact, many people’s mortgage rates have doubled since 2021.

We know the OCR has climbed, but is that the whole reason for skyrocketing interest rates?

With banks still recording record profits, you might be wondering where the extra money you are now paying for your mortgage actually goes.

Let’s take a look at the answer to where your money goes when interest rates rise.

Where Does My Money Go?

When interest rates rise, does the bank just pocket the extra money that you are paying?

The answer to that question is no. While banks are run as a business that needs to return a profit to their shareholders, they don’t simply take your additional interest payments as profit. Like any business, they have a product to sell and costs to cover. It just feels a little confusing as their product is money itself.

They need to lend out money at a higher rate than it costs them to acquire it. Plus, they need to cover all the usual costs of running a business, such as their staff and operational costs. Put simply, for the bank to continue functioning effectively, it needs to bring in more money than it gives out.

Interest rates bring funds into the banks. When their costs increase, interest rates must also increase to ensure the bank still operates with a profit.

The Role Of The OCR

To be able to lend money out, the bank must first obtain the funds to lend. One source of funding is from deposits in their customer’s checking and savings accounts, along with term deposits, loans, credit cards and the like.

The banks will put your money to work. While it is sitting in your accounts, you are effectively lending it to the bank, and they will pay you interest in return. Of course, your money is never gone, you can still access it at any time you need to.

In addition to using bank deposits as funding, the banks will also borrow money from the Reserve Bank and international sources. The OCR determines the cost of borrowing from the Reserve Bank. When this cost of borrowing goes up, the costs are passed down to the bank’s customers.

Likewise, if the OCR were to drop and the cost of borrowing fell, the bank would pass the savings onto its customers with lower mortgage rates. Movement in the OCR is one of the main reasons we see interest rates rise and fall.

Predicting The Future

When it comes to setting interest rates, there is an element of uncertainty for the banks. That is because, they cannot predict what will happen in one, two, or five years time. So, they need to factor that element of uncertainty into their rates.

For example, in 2021 all rate terms were under 3%. Now, in 2024, rates are above 6 and 7%. The cost of maintaining a 5-year fixed term that was agreed in 2021 has risen significantly which will ultimately impact the bank’s margin.

While using their expert economists to make reasonable predictions about what will happen in the future, there will always be unexpected circumstances that occur, such as a global pandemic! So, the interest rates they set must take a degree of uncertainty into account.

Your Money

As you can see, the extra money you pay does not just get gobbled up by your bank. It is simply that the cost of borrowing and lending increases and decreases depending on what is happening in the local and global economy. So, proportionally, the bank doesn’t take any more of your money when interest rates increase.

And, they may even end up giving some back to you. When mortgage rates go up, so does the amount of interest the bank will pay to you for any money you have in savings accounts etc.

But, no matter what the current financial state of the country is, you don’t want to pay more interest than necessary! A mortgage broker can help you with advice that is specific to your current situation, but as a general rule, it is wise to follow these tactics.

When mortgage rates are low and you expect them to increase, it is often best to lock in a longer term fixed rate for an element of financial stability. However, when mortgage rates are due to go down, shorter term fixed rates or even floating home loan rates can allow you to capitalise on any rate cuts when they occur.

When Will Rates Go Down?

The exact answer to the question of when interest rates will go down is still not clear. However, there is hope that positive news is not too far away. Many economists believe that we have finally hit the peak of mortgage pain.

We have already seen very minor reductions in rates and internationally, the interest rate cycle has turned. In the latest Monetary Policy Statement, the Reserve Bank has indicated they intend to keep the OCR at a steady level for a while longer, with potential cuts forecasted for the end of 2024.

Each of the major banks has varying opinions on when those cuts might take place, with some predicting August, some saying November, and others predicting cuts won’t happen until 2025. Opinions are still very much divided. The good news is that there’s a consensus that interest rate cuts are coming!

So, before making any decisions about refixing your mortgage or taking out new borrowing, we wholeheartedly recommend speaking with an experienced mortgage broker, like the team here at Mortgage Suite. We can give you helpful advice on what is the best move for your individual circumstances. Get in touch with us now.