Paul's Insights: Home loan loyalty doesn't pay

With a major financial product like a home loan, it can seem like a huge hassle to switch from one lender to another without a good reason. But a compelling reason can be tucked away out of sight.

Home owners are often reluctant to either refinance their mortgage or negotiate their home loan rate. Yet the Reserve Bank has pointed out that lenders often save their best deals for new customers, and a report by the Productivity Commission confirms this. 

The Commission says that existing home loan customers pay variable interest rates averaging 0.3% to 0.4% higher than new customers. On the average home loan that can mean paying an extra $66 to $87 per month just to stick with your current lender. Add that up over 25 years or so, and it’s a big dent in your finances.

Moreover, according to the Productivity Commission, very few borrowers actually pay a lender’s standard variable rate (SVR). Most people pay far less. But here’s the thing. Among existing home loan customers, 72% pay less than the SVR. When it comes to new customers, 91% pay below the SVR.

The upshot is that loyalty doesn’t always pay.

If you’re not happy with your current home loan or lender, refinancing to a new loan can be a money-saving option, and it’s generally a fairly straightforward process. The key pitfall to watch for is not going like for like on the loan term.

You may, for instance, be ten years into a 25-year loan. However, the decision to refinance could see the clock reset so that after refinancing you’re left facing another 25-year term. Who needs that? Extending the time taken to pay off your home just means paying even more in long term interest, which can defeat the whole purpose of switching. 

The solution is to talk to your lender or mortgage broker and explain that you want a term that matches the timeframe left on your original home loan.

Be sure to weigh up the costs and savings of refinancing too. The less time it takes to recoup the costs the better. If it costs, say, $1,000 to refinance, but you’re saving $200 each month on home loan repayments, it’s going to take five months to break even. That’s not too bad. If you have to wait, say, 12-18 months to recoup the costs, there’s every chance a better deal will come along before you’ve even covered the costs of switching to a new loan.

Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.