Home Loan Cashbacks - red hot deals can prove lukewarm

There’s something about a freebie that appeals to all of us. And if you’re chasing a better home loan deal by refinancing, a cashback payment can be very tempting.

Cashback offers have rapidly become a feature of today’s competitive mortgage market. And we’re not talking nickel and dime stuff either. How much lenders are willing to give away depends on how quickly they want to fill their loan books.

OneTwo Home Loans is the latest newcomer to arrive on the mortgage scene, and it was initially offering a whopping $5,000 cashback in March, which has since been scaled back. Instead it now offers to match any additional loan payments made in the first six months, up to $2,500 in total.

There are still plenty of solid cashbacks available, with the likes of St George, RAMS and Bank of Melbourne all offering $4,000.

I have to say though, I’m not a fan of cashback deals. They tend to distract borrowers from the main game, which is the loan rate and features. Banks don’t make annual profits measured in billions of dollars by giving money away, so you need to approach a cashback with a healthy dose of skepticism and ask what’s in it for you.

So, how does a cashback stack up against a low rate? Let’s look at the numbers.

On a $500,000 loan with a cashback of, say $4,000 and a rate of 1.89%, you’re going to pay interest of about $128,000 over a 25-year loan. Or, if you go with a lender asking a rate of 1.79%, and zero cash back, the long term interest cost will be less than $121,000.

That’s a difference of $7,000, which illustrates how a lower rate can deliver savings that eclipse the value of a cashback payment. In case you’re wondering, that 1.79% rate I’ve used is available with lenders like Pacific Mortgage Group.

Of course, not everyone will have a loan for the full 25 years, and lenders can, and do, alter their variable rates. But the example above shows how a small rate saving can outperform an upfront cash freebie.

These results aren’t surprising. A cashback may sound generous in dollar terms. But the average mortgage these days is just shy of $620,000[1], and even a substantial cashback represents just a tiny proportion of the loan value. The interest rate however, is something you’ll be paying year after year even if you subsequently refinance to a different lender.

That said, there is a way to make a cashback deal work in your favour. That’s by putting the cash straight into your home loan. This slashes the balance from day one, reduces monthly interest charges and puts you in front right from the start of your loan term. The catch is that this means resisting the urge to spend a cashback payment, and that calls for discipline.

The main point is that home loan borrowers need to focus on the loan rate and features. Anything else is icing on the cake, and a supersized cashback could just be masking a higher rate.

Effie Zahos is an independent Director of InvestSMART, money commentator at Canstar.com.au and Channel 9 Today Show.

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