The impact of rising interest rates on home mortgage borrowers has been a major focus since the Reserve Bank of Australia (RBA) began tightening monetary policy and regularly lifting the official cash rate from May 2022 onwards.

Understanding the Butterfly Effect: How Interest Rates Shape Borrowing Costs and Financial Plans

September 22, 2023

The impact of rising interest rates on home mortgage borrowers has been a major focus since the Reserve Bank of Australia (RBA) began tightening monetary policy and regularly lifting the official cash rate from May 2022 onwards.

However, the four big banks are predicting that the current phase of interest rate increases have reached their peak. The RBA has chosen to maintain the current interest rate of 4.10% for the second consecutive month. This decision comes as inflation begins to respond to monetary policy actions and the consensus is that the era of interest rate hikes has come to a close.

With interest rates in flux, it can be useful for businesses to understand the nature of interest rates and how they could affect operations and financing.

Understanding interest rates 

Interest charges are the most significant cost involved in borrowing money. While borrowers must repay the principal of the loan, they must also make regular payments to cover the lender’s cost of advancing funds. Lenders’ costs are based on the official cash rate set by the RBA.

The RBA uses increases in the official cash rate to slow down an overheated economy and curb inflation, as we have seen recently, and cash rate reductions to stimulate a sluggish economy.

How interest rate fluctuations impact business borrowing costs

Lenders (banks and other financial institutions) usually increase or reduce their interest rates in line with the RBA’s cash rate changes.

For borrowers with a variable-rate loan, the effect may be felt immediately. For example, each interest rate increase of 25 basis points is equivalent to an additional 0.25% per annum. This adds around $250 to the annual cost of a $100,000 variable rate interest-only loan.

When interest rates decline, the converse will occur. Lower interest rates translate to lower costs of borrowing. Businesses that have existing loans with variable interest rates will see a decrease in their interest payments, freeing up funds that can be used for other purposes.

How interest rate fluctuations impact business loan affordability

Higher interest may also reduce business borrowing power. Before approving personal and home loans, lenders are obliged by the Australian Prudential Regulation Authority to assess the borrower’s ability to repay the loan by paying the interest instalments.

This rule does not apply to business loans, which are assessed on a case-by-case basis and not subject to the same laws as consumer lending. However, the lender may still consider your business’s financial statements and cash flow.

Lower interest rates mean that the cost of borrowing capital is reduced, making it easier for businesses to access the funding they need to expand, invest, or manage cash flow. New loans and credit facilities become more affordable for businesses.

Business planning for fluctuating interest rates

Fluctuations in interest rates can impact different areas of your business. Here are some key considerations and strategies for business planning in the face of fluctuating interest rates:

  • Review and Forecast: Regularly review your current financial situation, outstanding loans, and interest rate exposure.
  • Adjust Pricing: Evaluate whether your pricing strategy should be adjusted to accommodate changes in borrowing costs. In a rising rate environment, you might need to adjust your pricing to maintain profit margins with higher borrowing expenses.
  • Customer Behaviour Analysis: Anticipate changes in customer behaviour as interest rates fluctuate. For instance, lower rates might lead to increased consumer spending and demand in certain industries.
  • Scenario Planning: Develop contingency plans for different interest rate scenarios, including both upward and downward movements. Having a clear plan in place for various situations can help you respond swiftly to changing conditions.

Consult your finance broker for interest rate impact advice.

If you need further guidance about how interest rate fluctuations may impact your business and your ability to borrow, we’re always available to answer your questions and provide tailored advice. We can also help you access business finance at the best available rate.

This information is for general information purposes only. The information contained herein does not constitute financial or professional advice or a recommendation. It has not been prepared with reference to your financial circumstances or business and should not be relied on as such. You should seek your own independent financial, legal and taxation advice as to whether or not this information is appropriate for you.

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