The Home Loan Product Myth
Did you ever buy a new car? Six months after you took delivery did the dealer ever phone you and say something like this:
“I’ve got great news! Our wholesale costs have gone down and I can take $500 off the price of the car. I’ll send you a cheque at the end of next week.”?
And did they phone again a few months later to say:.
“Sorry, our dealership costs have gone up, there are some new government regulations we have to comply with, can I please have another $1,200 for the car.” ?
Of course, this story just is not plausible. When you make most purchases the price you pay for the product is set at the time of purchase and is not subject to further negotiation. So why is it different with home loans? The interest rate is the lender’s price for the product yet they are regularly unilaterally adjusting it. They even write this power into loan contracts.
There are only two “products” sold in Australia where the price is continually being adjusted after you make the initial purchase decision: insurance policies and home loans. The reality is that neither of these items is really a product. They are an ongoing SERVICE and are therefore subject to ongoing changes in the nature of the service, its price and sometimes even its provider.
So let’s have a look at how this works in the home loan industry – it’s what I call the Interest Rate Game!
The Playing of the Game
Consider two players in the game: Borrowers 1 and 2.
In January 2015, Borrower 1 is buying a house and they need to borrow $450,000 to complete their purchase. They take out a loan with ABC Bank at a (then) very competitive interest rate of 4.83% pa. The loan settles and they move into their house.
Then over the subsequent 4 years they receive a series of letters from their lender to inform that their interest rate has been “adjusted”. Sometimes these adjustments will be simultaneous with RBA cash rate movements. In other cases the lender will cite “market conditions” or “regulatory requirements” to explain away their decisions.
For example, in January 2016 ABC Bank writes a letter to all its customers saying that “due to market conditions as well as regulatory changes which require the major trading banks to increase the amount of capital they hold against their home loan portfolios we have had to regrettably increase our interest rates”. And they simply add on an 18 bps (0.18% pa) increase to ALL of their customers.
Overall, for a loan taken out in January 2015 the interest rate movements will look something like the those set out in Table 1:
The whole series of rate movements (price adjustments) is summarised in Table 1. You could be forgiven for thinking that since all lenders make these adjustments, very often simultaneously, and that they apply equally to all borrowers that the process is somehow fair and equitable. But let’s take a look at the experience of the other borrower.
In January 2018, Borrower 2 is buying a house and they need to borrow $450,000 to complete their purchase. They take out a loan with ABC Bank at a very competitive interest rate of 3.68% pa. The loan settles and they move into their house. Note that this is an IDENTICAL scenario to that of Borrower 1: the loan amount , the loan purpose, and even the lender are exactly the same.
Again their lender makes interest rate adjustments along the way.
Families 1 and 2 borrow the SAME loan amount from the SAME lender. Tables 1 and 2 show their initial borrowing rates and rates prevailing in Feb 2019. Borrower 2, who borrowed only 3 years after Borrower 1 is paying 0.56% pa more for the SAME SERVICE!
The Lenders’ Sleight of Hand
When you take out a variable rate home loan the interest rate is ONLY THE INITIAL PRICE of the product (or more correctly - the service).
Due to the competitive nature of the market lenders work hard to make sure that this initial price is as low as possible, and then work afterwards to build in the price margin they gave away to secure your business. They know that most people mainly concentrate on their interest rate at the time of initial purchase. They also know that even if borrowers are inclined to refinance that the costs of refinancing often make the switch uneconomic.
Tactics Used By Lenders
Lenders will use a range of tactics to entice new borrowers. Some you will see currently being advertised strongly are:
2 year fixed rate specials (hint: look at the variable rate behind it)
Cash backs of up to $2,000
Frequent flyer points
Each of these tactics is calculated to take advantage of borrower inertia. Lenders know that many people simply do not want to go through the hassle (and incur the cost) of refinancing. And this is particularly the case where the banking relationship is more complex; a refinance might involve changing over a series of direct debits, credit card links and so on. So it is worth their while to provide inducements to get a borrower on to their books.
Tactics for Borrowers
For borrowers there are counter tactics available to ensure that your loan remains competitive over the longer term. These include:
Renegotiate with your lender:
it costs nothing
it very often yields a competitive outcome
Refinance to a new lender
costs around $1,000
be careful that you’re not just jumping from the frying pan to fire
beware lender cash rebates - yes, they are considered a marketing cost but they are rarely offered by lenders with the most competitive interest rates
Fix your interest rate
Existing borrowers obtain the same rates as new customers, BUT
fixed loans are less flexible and you may lose some loan features
fixed loans generally should not be contemplated by borrowers looking to pay off their loan quickly
fixed loans are not suitable for borrowers intending to sell their property during the fixed rate term.
A home loan is a SERVICE, not a product and is therefore subject to ongoing changes in the nature of the service, its price and sometimes even its provider.
If you borrow money you are playing the interest rate game. Like every other game those with the best knowledge of the rules have the best chance of winning.
Disclaimer: This article is intended to provide general news and information only. While every care has been taken to ensure the accuracy of the information it contains, neither Loanscape nor its employees can be held liable for any inaccuracies, errors or omission. All information is current as at publication release and the publisher takes no responsibility for any factors that may change thereafter. Readers are advised to contact their financial adviser, broker or accountant before making any investment decisions and should not rely on this article as a substitute for professional advice.