10 October 2008

You have probably noticed a few worrying things happening in financial circles lately. The share market has fallen through the floor again, central bank mandarins are making the nightly news and the banks and loan providers are increasing the differential on loans yet again.

There have been 12 interest rate rises since May 2002, what you may not have noticed is the extra increases over and above the Reserve Bank of Australia's rate increases that the banks and other loan providers have passed on as well.

Since November 2007, the differential between the RBA Cash Target Rate and the average Banks Standard Variable loan has increased from 1.8% to about 2.6%. Compared to last year, mortgage holders are now paying an extra 0.8% on their home loan due to the sub prime credit crunch issue.

On a mortgage of $250,000, this equates to an extra $133.40 per month.

It's bad enough that rates have gone up but to be slugged an extra 0.80% for no apparent good reason is a concern.

The reason this has happened is because the cost of borrowing funds for our Australian banks has increased. Let's call it the wholesale interest rate. In the past financial institutions used to take deposits from customers and lend these funds to other customers at a higher rate of interest taking the difference as revenue. Now banks seek sources of credit from the global credit market and herein lies the problem.

As part of their monetary policy back in 2002-2004 the US Federal Reserve lowered their Federal Funds Rate to 1%. This meant that mortgage borrowers could access loans that touched as low as 3.5%.

Together with aggressive lending practices meant that a large number of new borrowers got into the housing market or borrowed more than was reasonable. When interest rates rose to over 5.5% the increase in loan repayments was more than many could handle.

Repayments increased by roughly 57% and when you borrow as much as you are allowed with the initial repayments around 35% of your salary an increase like that hurts.

This has directly lead to a great deal of financial stress on a significant portion of the US population.

These new borrowers could not repay their loans and started defaulting on their loans. These same loans had been aggregated, collateralised and sold into the global debt markets. This started causing widespread concern amongst the credit providers in the market.

Suspicion over who held this bad debt and the ability, of the holders to remain solvent caused lenders to stop lending to almost every one.

This has lead to the wholesale credit rates rising significantly as the cost increases to adjust for the perceived or real risk.

This is why the differential between the RBA Cash Target Rate and Bank Standard Variable Rate has blown out to around 2.6%.

What can you do about it?

With 14 million credit card accounts in Australia, there are many people with multiple credit cards and with interest rates ranging roughly from around 12% to 25% there are some simple things you can do to save money. To ease your cash flow burden and claim back some of that lost interest here's what you can do:

Step 1 - Compare your current interest rate

Click here to compare interest rates for:

• Low rate credit cards

Step 2 - Consider a balance transfer

The second thing is to consider a credit card balance transfer. A balance transfer is where the balance outstanding on your current card or cards is transferred to another credit card provider. There are some credit card balance transfer deals where you can pay little or no interest on the balance transferred for periods ranging from 6 to 12 months. Click here to compare credit card balance transfer deals.

Disclaimer: Please check with your current credit or loan provider to ascertain any fees associated with exiting your current arrangement.

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