Home loan interest rate discounts – an idiot's guide

By September 7, 2016 March 8th, 2018 Mortgages

This short blog will provide you with the tools and knowledge to negotiate the best interest rate discount on your mortgage/s.

The banks leave themselves open to price competition

Much has been written lately about whether the banks will be able to maintain their enormous profits (and dividends) in a low interest rate environment. The banks themselves certainly haven’t helped their own cause by aggressive discounting rates for new borrowers. It’s almost an admission that they cannot compete on product and service so the only thing left is price competition (i.e. interest rates).

A 2% margin is awesome – one of the best in the world

The banks net interest rate margin is around 2% p.a. – this is the difference between what they charge you and what they pay for their borrowings – it’s their gross profit. The Australian banking industry has some of the fattest net interest rate margins in the world. They have been unaffected by the GFC. It is true that higher deposit rates will put pressure on bank margins except that it doesn’t seem to have had any impact yet, so ignore the rhetoric that comes out of the banks (they use higher deposit rates as an excuse for not passing on the full RBA cuts).

Rates can only fall so far –the floor is 3.00% to 3.50% p.a.

According to RBA data, the average standard variable interest rate is 5.25% p.a. However, most new borrowers are enjoying discounts of at least 1.20% p.a. so the actual rate that many borrowers are paying is close to, or below, 4% p.a. Given the banks’ net interest rates margin is 2% (i.e. that’s the gross profit they want to maintain), then I cannot see interest rates falling below say 3.00% to 3.50% p.a. – even if the RBA cuts the cash rate to zero (currently 1.50%).

In the UK, the cash rate is 0.25% p.a. and variable home loan rates are in the range of 2% and 3% p.a. (because the UK’s net interest rate margins are lower). So don’t expect rates to fall below 3% irrespective of what the RBA does.

Lazy customers are subsidising new customers

The banks have been pretty smart about home loan pricing. What they have done since the beginning of the GFC is not passed on all of the RBA rate cuts to their customers. This means that their profit margins on older home loans is quite large. They have increased discounts on new home loans or for existing customers if they have complained. The banks have large home loan back books e.g. people that took out a mortgage 10 years ago and haven’t bothered to check the interest rate.  These customers are essentially subsidising the interest rates being offered to new borrowers. If you haven’t had a mortgage broker check your interest rate in the last 5 years you should do it today.

Best time for discounts is March to July – register here

Over the past few years we have noticed an interest rate discounting cycle leading up to the banks end of financial year (which is September). The banks are typically the most aggressive between the months of May and July because they want to win as many new customers as possible (whilst leaving enough time to get the new loans established prior to the end of the financial year). The share market punishes banks that lose market share. So most banks would like to report that they have grown at a faster rate than their peers. One way to achieve this is to use a discounting strategy to get an influx of new customers which they typically start doing in March.

Take advantage of this cycle and diarise to review your interest rate after March 2017. Or better still, register below and we will do it for you.

 

 

The lowest rate sometimes ends up costing you $$$$

A word of warning with respect to selecting the absolute lowest rate in the market. If profit margins are thin, businesses have less money to spend (invest) on their product and services – they have to cut costs somewhere. Of course it depends on your circumstances but typically, people with large home loans and/or investors need to consider things such as the speed of approvals, borrowing capacity criteria, lending policies and the lenders ability to structure the loan effectively. There’s no point moving to a lender if they are not going to allow you to borrow to build wealth. This doesn’t mean you have to pay more for this. It simply means that selecting a lender that might offer you a rate 0.05% p.a. lower might actually end up costing you in other ways. What you want to aim for is fair pricing i.e. the lowest interest rate that a comparable lender will offer you for a comparable product.

What you might lose in high rates – you might gain in higher super

The top 5 banks (being the Big Four + Macquarie) account for 26% of the ASX200 share index. Therefore, it is likely that a reasonable proportion of your super is invested in the banks. Therefore, you benefit from the banks maintaining their interest rate margins through share price appreciation and dividends. So whilst the banks profit-motivated behaviour might rile you up at times, you can take some comfort that your super will probably benefit.

Using a mortgage broker is a good long term solution to this problem

Latest data suggests that mortgage brokers are responsible for establishing 52.6% of new mortgages. I expect that this number will increase in the coming years as more borrowers appreciate the benefit of having someone sit on their side of the table. From brokers’ selfish commercial perspective, they don’t care which lender you use (as commission rates don’t vary much). Also, the vast majority of brokers are paid the same irrespective of the interest rate discount you receive – check to make sure this is the case before you use a broker. Therefore, a broker is only motivated by getting their clients the lowest rate with the most appropriate lender for the client. There is also no disincentive to presenting offers from other banks. This means that most brokers will represent your best interest and review your loan regularly to ensure you are always receiving a fair rate.