Written byA base rate is the reference interest rate a lender starts from, before it adds the margin, or spread, that reflects the borrower and the term.
Also known as: reference rate, benchmark rate, base lending rate
Key points
- Lenders build a rate in two parts: a base rate they do not control, plus a margin they set for each customer.
- Common base rates include the Reserve Bank cash rate target, the bank bill swap rate, and a lender's own standard variable rate.
- The base rate on its own tells you little, so compare the comparison rate or the total cost over the full term.
- Changes are usually quoted in basis points, where one hundred basis points equals one percentage point.
How a base rate works
Think of the rate on a loan as two layers. The bottom layer is the base rate: a reference rate drawn from the market, or a benchmark the lender publishes itself. It reflects what money costs the lender, not what the individual borrower costs the lender. The top layer is the margin, which covers credit risk, the security taken and the lender's return. Lenders and brokers use margin and spread interchangeably for that gap over a benchmark.
Added together they give the interest rate written into the contract. On a fixed rate loan both layers are locked at settlement for the fixed period. On a variable loan the base rate can move, and the lender passes some or all of that movement through to you.
Which base rates lenders use
There is no single base rate in Australia. Consumer lenders usually anchor to the cash rate target set by the RBA, which is the rate the central bank uses to steer the price of money. Business and asset funders more often use the bank bill swap rate, because it is closer to what it actually costs them to raise money for a set period.
Some lenders publish their own base rate instead, such as a standard variable rate or a reference rate for equipment finance. That version is set by the lender, so it does not always move in step with the market. Whichever benchmark applies, the gap between it and the rate you are offered is the margin.
What the base rate means for borrowers
When you compare finance, the useful question is not what the base rate is but how much sits on top of it. Two lenders can start from the same benchmark and quote very different rates, because their margins, fees and appetite for risk are different.
If your loan is variable, ask what the lender treats as its base rate and whether it commits to passing changes through. If it is fixed, the base rate at settlement is locked for the fixed period, so timing matters more than tracking. A broker can show you how different lenders build their pricing.
Example
A courier business gets two quotes to finance a $55,000 van. Both lenders start from the same market benchmark as their base rate, but one adds a smaller margin because the business has three years of trading history and the van is a common model that is easy to resell. Same base rate, different margin, different repayment. If the benchmark later moves, the variable quote moves with it while the fixed quote stays where it is for the fixed period.
Not to be confused with
- Comparison rate
- a comparison rate folds fees into a single number, while a base rate is only the starting benchmark
- Variable rate
- a variable rate is the rate on your contract; a base rate is the benchmark sitting underneath it
Frequently asked questions
What does base rate mean on a loan?
It is the benchmark the lender prices from. The lender takes the base rate, adds a margin for your credit history, the security and the term, and the total is the rate on your contract. You rarely pay the base rate itself.
Is the base rate the same as the cash rate?
Not always. The cash rate target is one common base rate, especially for consumer lending, but lenders also use the bank bill swap rate or their own published reference rate. Ask which benchmark a lender uses, because it decides how your rate responds to market moves.
How does a change in the base rate affect my repayments?
On a variable loan, a rise in the base rate usually flows through to a higher rate and higher repayments, and a fall can do the opposite. Lenders are not always obliged to pass on the full move. On a fixed loan nothing changes until the fixed period ends.
Why do lenders charge more than the base rate?
The base rate only covers what the money costs them. On top of that they need to cover the risk that a loan is not repaid, the cost of assessing and administering it, and a return for shareholders. Riskier borrowers and harder to resell assets attract a larger margin.
Does the base rate apply to fixed rate loans?
Yes, but only at the start. The lender prices the fixed rate off a benchmark for that term when the contract is written, then locks it in. After that, movements in the base rate do not change your repayments until the fixed period ends.
Related terms
RBA
The RBA (Reserve Bank of Australia) is Australia's central bank: it sets the cash rate that flows through to loan and savings rates, and operates key payment settlement systems.
Read definitionVariable rate
A variable rate is an interest rate that can move up or down over the life of a loan, following the lender's benchmark and its margin.
Read definitionFixed rate
A fixed rate is an interest rate locked in for a set term, so the rate and usually the repayments do not change until that term ends.
Read definitionComparison rate
A comparison rate is a single annual percentage that combines a loan's interest rate with most upfront and ongoing fees to show its ongoing cost more clearly.
Read definitionSpread (finance)
A spread is the difference between two related rates or prices, such as a lender's rate and its benchmark, or an asset's buy and sell price.
Read definitionBasis point
A basis point (bps) is a unit equal to one hundredth of a percentage point, used to express small changes in interest rates, yields, fees and spreads.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.