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Cash rate. Interest rate. What is the difference?

Updated: Nov 15, 2022

What is the difference between the cash rate and your interest rate?

The most important difference inherent in these two rates, is the simple fact that one is out of your control, the other is often more within your control than you think.

If I could preface this blog with one piece of advice, it is focus on what you can control.

With so many different rates being quoted in the media, I have been fielding a lot of questions about the different definitions of rates, and what they mean to you, the end customer.

1. Cash Rate - This is the big one. The one that you and I cannot control. Only Phillip Lowe and the Reserve Bank of Australia can.

Believe it or not, banks borrow money too. In fact they frequently lend money to each other to cover certain shortfalls. The RBA sets the ‘overnight money market interest rate’. This is the rate they use to lend money to each other. The Cash Rate.

When the RBA raises the cash rate, it increases the cost of interbank lending. Now banks being shrewd businesses, don’t cop this rate rise on the chin, they pass it on to you, the end customer. They almost always raise your effective interest rate, if the RBA raises the cash rate..

“If the price of milk rises by 10%, your coffee shop owner can either cop that rise on the chin, or raise the cost of your coffee by 10%”

At the time of writing this article, that rate is 2.85%

2. Interest Rate (IR) - This is the base interest rate set by your lender of choice. This rate is typically increased by your lender when the RBA increases the cash rate. It may also be decreased to new applicants by your lender to attract more business. This is still not the rate that you’ll be typically charged. I’ll use one of the top 4 banks to demonstrate.

At the time of writing this article, that variable rate is 6.03%

3. Effective Interest Rate (EIR) - This is the important one for YOU. This is the rate YOU pay. The majority of a bank’s customers get a discount to their quoted interest rate. This discount is based on numerous variables. Your LVR (loan to value ratio), your DTI (Debt to income ratio), your credit history, your employment, the type of property you are purchasing etc etc etc.

“The less risky you are to a bank, the bigger the discount, the lower your effective rate”

Let's say you're a model applicant. Your credit history is perfect, you are only borrowing 50% of your property’s value, you have a steady employment, and you’ve bought a free standing house in a nice area. You might get the full discount of say 1.74%.

Your effective Interest rate = 6.03% - 1.74%


On the other hand, if you are a Matador, purchasing a hacienda in rural NSW, borrowing 95% of the value of your property, and have missed the last 3 payments on your credit card - you’re either going to miss out all together, or pay an effective rate of the entire 6.03%

Following this article - I’ll explain how to reduce your effective interest rate, and pay less interest over the life of your loan.

How to reduce your interest rate right now, click below:


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