Bank Assessment and Interest Rates Explained – Why It’s Important When Applying For a Home Loan

Most people think that interest rates are what help a lender calculate how much they can lend to a potential borrower. However, this is not how such rates work.

For example, each lender comes with a standard variable interest rate that they will apply to their variable rate home loan products. However, when they are looking at your borrowing power to calculate how much you can borrow, they will use an altered rate that is higher than their variable rate.

They use a higher rate in order to account for any possible future increase in interest rate. This rate is known as the assessment rate.

How Do Banks Set Interest Rates, How Are They Determined?

The standard variable rate of each lender must use the cash rate of the Reserve Bank of Australia (RBA) as a base rate, this is the cost of funds incurred to the bank, whatever the bank sets above the RBA cash rate, is the lenders mark up or gross profit. For example, if the RBA has set their cash rate at 1% and the lender has their variable rate at 3%, their gross profit margin is 2%.

When your lender is assessing your home loan application, they can add up to 2-3% onto the previously mentioned standard variable rate. The rate that is resulted from this equation is then used to determine your ability to make repayments towards your loan.

Basically, the assessment rate is there to cover both the lender and the borrower in case the cash rate of the RBA increases. This is because an increased cash rate comes with a higher standard variable rate – in short, you pay more interest per month.

Naturally, if the cash rate decreases, you end up paying less interest per month as your lender will have to lower their interest rate.

Benefits of the Assessment Rate

As expected, this rate protects both you and the lender. The extra percentage that the lender adds to their standard variable rate is meant to provide them with a buffer.

This buffer ensures that they can make a profit on the loan while making them certain that they can cover the costs that come with providing the loan.

On the other hand, it protects you as well. By adding the extra percentage, the lender ensures the fact that you will be able to make repayments towards your loan even if circumstances change. In short, the bank assessment rate protects your financial future.

How Do Assessment Rates Affect Loan Applications?

When taking into account the assessment rate, a lender assumes that you will be paying more interest than you actually will on your home loan. If your current income does not cover this extra interest brought up by the assessment rate, then your application may be denied.

The Bottom Line

You must not see the assessment rates as something in your way of getting a home loan approved. As mentioned above, they make sure that, no matter the future circumstances, you will still be able to repay your loan.

Assessment rates can be seen as a safety net for both lenders and borrowers. If you have any more questions about such rates or need information regarding home loans, feel free to contact our office.

We will provide you with all the information you need and guide you through the process of finding the best loan for you. Just reach out and contact us today – we’ll help you in any way we can!

Contact us on 02 8530 1107 or Submit your scenario online