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How do your decisions affect the rate of interest you pay?

interest rateIn days gone by, the RBA would make a cash rate decision which would then flow through to the interest rate offered by a lender. The major lenders would offer more or less the same rate, which would increase (or decrease) by the same amount and the news headline of the day was all about the lender who raised their rates first. If you studied this carefully, you would also notice that the lender who increased their rates first seemed to change each time – resulting in the negative media attention being shared around.

But those days are well and truly gone.

With reported increased funding costs, global banking pressures, national housing pressures and as well as increased attention from regulators, there have been big changes to interest rates. Not so much in terms of seeing large increases or decreases to the rates, but more so in terms of why (and how) rates vary between lenders.

Interest rates are used as a bit of a lever. Lowering rates can encourage more borrowers to consider a particular type of loan, whilst raising rates can steer borrowers away from a specific type of loan or lender.

A lender’s decision to change the interest rates will be based on financial modelling – as it always has been. What’s different now however, is that lenders are offering a suite of rates that vary according to the type of loan, as well as a borrower’s specific situation.

Lenders are making some loans more expensive than others in an attempt to steer borrowers towards certain types of loans, so they meet regulatory requirements.

Since one lender’s loan book will be different to another (i.e. one may have a higher % of Owner Occupier loans whilst another may have a higher % of Interest Only loans), each lender will need to apply different pricing strategies based on close they are – at a particular point in time – to reaching the maximum allowable % of investment loans.  Accordingly, we expect lenders to continue to tweak their rates taking into account the short and long-term objectives they’re trying to achieve behind the scenes.

Whilst it’s important to understand the reasoning for all these variances from the lender’s point of view, it’s more important to understand how it affects you.

 

As a borrower, are there specific decisions you can make to ensure you’re not paying more interest than you have to?

In some cases there are…  it depends on a few factors. 

 

What’s the purpose of the Loan – Owner Occupier or Investment?

As we know, lenders are now limited in terms of how much of their overall loan book is allowed to consist of investment loans. In addition, lenders can only grow the volume of their investment loan book by 10% per year.

When these restrictions were first introduced, we saw lenders limit their level of investment lending by raising the interest rates on investment loans.  By making these types of loans expensive, lenders hoped to make these loans less appealing, helping the lender to comply with their investment loan cap.

As investment lending volumes increase throughout the year,  it’s likely some lenders will approach these limits. In such circumstances, we can expect the affected lenders to increase their rates on investment loans or introduce other measures to (temporarily) discourage this type of lending whilst they attempt to adhere to imposed regulations.

Generally, the interest rate on owner occupied loans is lower than the rate on an investment loan.

 

What type of repayment are you making – Principle & Interest or Interest Only?

The level of household debt is rising and it’s something economists have been commenting on. It’s something the RBA has been monitoring too – as shown by the recent media releases following their monthly board meetings.

When you choose to make Interest Only repayments on your owner occupier loan, you won’t pay down your loan by only making the minimum monthly repayment. As we’ve discussed before, whilst Interest Only loans can provide flexibility, you need to build up sufficient cash in a linked offset account (or making additional payments into the loan) to ensure you’re don’t pay more in interest over the long term. If you don’t follow through with this strategy, you’re not actively doing anything to reduce your household debt and you’re solely relying on increasing house prices to improve your net asset position.

To encourage borrowers to actively work towards reducing their debt levels – and reduce the number of Interest Only loans on their books – lenders have started to offer different interest rates based on the type of repayment you choose.

Generally, the interest rate is lower if you choose to make Principle & Interest repayments.

If you’re currently making Interest Only repayments on an Owner Occupied loan, it’s time to think about switching over to Principle & Interest repayments. Making the switch might help you to reduce the rate of interest, as well as ensure you stick to the plan of actively reducing your net debt.

 

How much are you borrowing? 

In times gone past, it used to be that the more you borrowed, the greater the discount a lender would offer you off the standard variable rate.  This is especially the case for ‘professional package’ borrowers.

However, now the loan to Value to Ratio (LVR) can play a role.  If you’re borrowing more than 80% of the purchase price, it’s often the case the case that lenders are not as generous with their additional pricing discounts.

 

It’s not so simple anymore

So, the interest rate you’re paying (or more accurately the lifetime discount a lender will offer YOU off the standard variable rate)  can depend on the amount of the loan; how much you’re borrowing compared to the value of the property; what other lenders are offering at the time; what you want the loan for; the type of repayment; as well as the colour of your hair. Ok, maybe not the last one.

The takeaway message is that rates are getting personal. A lender will offer you a rate based on your personal situation and their  assessment of your potential risk as a borrower, but it will also take into account their broader objectives and desire to satisfy regulatory requirements.

Not surprisingly, it’s getting even more important you have an experienced mortgage professional on your side. Someone who will present your situation to the right lender in the right way to ensure you achieve the best outcomes. Someone who has a proven track record of securing great rate discounts for their clients. And someone who understands the new environment we’re operating in.

 

 

 

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