Paul's Insights: A cash lure can be easy bait
According to RateCity, 29 lenders are offering cashback payments to home owners who refinance their mortgage.
The cash splash ranges from $1,000 to $4,000 per refinance, and not surprisingly, these deals are generating lots of enthusiasm for switching. Between April and August 2020, over 137,000 Australians refinanced their home loan. But being paid a wad of cash to move to a new loan isn’t always the sign of a good deal.
On one hand, the growth of cashback perks highlights how competitive the mortgage market is. There’s more to it than that though. Behavioural psychology shows that humans can easily fall for ‘anchoring’ – that’s our tendency to focus on an opening number rather than objectively comparing prices and values. Put simply, the prospect of being paid several thousand dollars to refinance starts to dominate our thinking, and deters us from shopping around or taking a closer look at loan rates and fees.
When it comes to money matters, it always pays to put things in perspective. The average home loan under two years old is currently worth $456,000. So a cashback of, say, $2,000, which may sound like a lot, amounts to less than 0.5% of the loan value. Over a 25-year term, the rate you pay is the biggest factor that will shape the loan cost.
RateCity crunched the numbers and found cashback deals were typically more expensive in the long term. So, it’s important to do the sums to see if refinancing puts you ahead financially – and not just at the point of switching to a new loan.
Always check if the rate is competitive – and in today’s market that usually means a rate starting with a ‘2’ or below. Check the loan fees and be prepared to pay hard ball, asking the lender to waive the fees if you believe they’re expensive. Where possible, tip a cashback into your loan as an extra repayment – it can knock a good chunk off the overall interest bill.
Remember too, not everyone will be able to switch to a new loan. Lenders generally like to see that you have a steady job and a deposit of around 20% deposit or the equivalent in home equity before they’ll go ahead with a refinance.
Paul Clitheroe is Chairman of InvestSMART, Chair of the Ecstra Foundation and chief commentator for Money Magazine.
Frequently Asked Questions about this Article…
A cashback offer in mortgage refinancing is a financial incentive provided by lenders to homeowners who switch their mortgage to a new lender. These offers can range from $1,000 to $4,000, aiming to attract borrowers to refinance their home loans.
Cashback offers are popular because they provide immediate financial benefits, making the idea of refinancing more appealing. However, it's important to consider the long-term costs and not just the upfront cash incentive.
Not necessarily. While cashback offers can be enticing, they may not always result in the best financial outcome. It's crucial to compare loan rates and fees, as cashback deals can be more expensive in the long run.
To determine if a refinancing offer is beneficial, compare the interest rates and fees of the new loan with your current one. Ensure the new rate is competitive, ideally starting with a '2' or below, and calculate the long-term savings versus the immediate cashback.
If you decide to refinance and receive a cashback, consider using it as an extra repayment towards your loan. This can help reduce the overall interest bill and shorten the loan term.
Before refinancing, consider the interest rate, loan fees, and your financial stability. Ensure you have a steady job and sufficient home equity, as lenders typically require a 20% deposit or equivalent equity for refinancing.
'Anchoring' is a behavioral psychology concept where individuals focus on an initial number, such as a cashback offer, rather than objectively comparing all aspects of a deal. This can lead to overlooking important factors like interest rates and fees.
The average value of a home loan under two years old in Australia is currently around $456,000. This context is important when evaluating the significance of a cashback offer relative to the overall loan amount.
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