How Are Interest Rates Determined?

How do lenders set home loan interest rates and what are their lending costs?

With interest rate rises and official cash rate becoming buzzwords in the media for 2023, you may be left wondering what it all means and how lenders determine the interest rates (aka ‘price’) of their home loans.

What is the official cash rate?

The official cash rate is the interest rate charged by the Reserve Bank of Australia (RBA) to financial institutions (that’s us!) and plays an important role in how interest rates are set. These changes help manage the growth of the economy, and impact costs involved with lending money.

What are the typical costs of lending money?

You might be thinking the margin that lenders make is just the ‘interest rate’ minus ‘the cash rate’, right? Not quite. There are four costs involved with lending money.

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Cost of Funds

The cost of getting access to funds to lend. This is typically made up of:  

  • Deposit rates that are paid to deposit holders.
  • Money borrowed in domestic and international markets.

Cost of Insurances

The cost to manage differences in rate between different funding sources - this helps keep the rate steady, otherwise, you could see a lot more rate changes than you see today. This is made up of hedging positions (such as overnight index swaps) to help manage any mismatches in rate between the different funding sources. This is known as basis risk premium.

Cost of Capital Reserves

Whenever money is lent to customers, cash needs to be held to protect against any losses (e.g. loans that go unpaid) that may occur. This is required by regulators to keep Australia’s financial system safe.

Our Margin

This is what Unloan recognises as our revenue. This revenue needs to cover the costs of running a lending business (including marketing, technology and salaries).  

So how does Unloan keep rates low?

Unloan is built to deliver a simpler home loan experience at a lower price.  

As a digital lender, we’ve removed many of the traditional overheads to keep our costs low. These include:

  • We don’t pay commission to brokers
  • We don’t pay cashback incentives to customers
  • We don’t have branches  

We also use technology to automate many of the traditional lending processes – making Unloan’s customer experience faster and simpler.

Unloan’s ongoing focus on simplicity and value allows us to continue offering a lower price to our customers.

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