Home loan loyalty tax costs Australian home owners thousands per year

Long-term home loan customers with the big four banks are paying interest rates an average of 0.26 of a percentage point higher than new customers, an ACCC inquiry into bank interest rates found.

The “loyalty tax” paid by borrowers is even greater for loans more than five years old, with average interest rates 0.4 of a percentage point higher than those offered to new customers.

That means a typical borrower could be unnecessarily parting ways with thousands of dollars each year, just by sticking with their current lender.

In the words of ACCC chairman Rod Sims, “if you haven’t rung your bank up in the past couple of years, you’re probably paying too much”.

Australians paying too much on their mortgage is a massive problem. Home loan platform Lendi’s co-founder and chief executive and Domain Home Loans director David Hyman argues millions of Australians’ interest rates are too high.

“There’s roughly five million outstanding mortgages and only 300,000 people refinance each year,” he says. That means 94 per cent of home owners have an opportunity to talk to their bank about getting a better rate on their loan.

Hyman believes ACCC’s figures are conservative. “We’ve seen the loyalty tax range between 0.7 per cent and 0.85 per cent. That’s a very significant amount if you have a $500,000 mortgage.”

In fact, it’s $4000 every year. Or $80,000 across the life of a 20-year mortgage. And the bigger the loan, the higher the tax.

“If your rate does not start with a two, you’re paying too much, regardless of whether you’re an investor or an owner-occupier,” Hyman said.

The median interest rate for owner-occupiers with principal-and-interest loans who refinanced with Lendi in April was 2.72 per cent, but some borrowers have been able to secure even lower rates.

“We’re seeing rates of 2.09 per cent for a principal-and-interest, owner-occupier loan,” Hyman adds.

Golden Eggs’ financial adviser Max Phelps notes there’s a disparity in how much extra interest borrowers pay depending on the type of loan they have.

“It depends whether you’re an owner-occupier or investor, whether the loan is principal-and-interest or interest-only and whether the loan is fixed or variable,” he said.

“A lot of people with interest-only loans pay more than 4 per cent. They could switch to a principal-and-interest loan and pay less than 3 per cent, with a 1 per cent saving worth $5000 a year.”

Borrowers giving away money

The flipside is how much extra the banks earn in interest as a result of what amounts to borrower apathy when it comes to refinancing.

“There’s $1.7 trillion in outstanding mortgages in Australia. So there’s a huge magnitude in savings for customers who decide to take matters into their own hands and go ahead and refinance,” Hyman notes.

In 2019 the Commonwealth Bank’s loan book was just under $500 billion, which equates to around $90 billion in new lending and around $400 billion in existing loans. The bank makes between $1.2 billion and $1.5 billion in extra revenue each year, assuming it earns between 0.3 per cent and 0.5 per cent a year extra as a result of people failing to negotiate their rate.

“CBA has 25 per cent market share, so that equates to $4.8 billion to $6 billion in extra interest for the industry just because people are not refinancing their loans,” says Phelps.

Investors are the worst hit. Until 2016, there was one rate, regardless of whether a loan was taken out by an owner-occupier or an investor and whether the loan was interest-only or principal-and-interest.

“The banks’ response to APRA’s push to reduce interest-only and investment lending created a 1 per cent difference between the highest-rate, interest-only investment loan and the lowest, owner-occupier principal-and-interest loan,” says Phelps. “Yet the difference in cost of funds to the banks is only around 0.1 per cent.”

Reducing red tape

Banks may not be proactively contacting customers to offer them a more attractive rate on their home loan. But they are making it easier to switch to a loan with a lower rate.

As a result of social distancing stemming from the COVID-19 outbreak, the big banks, the non-banks and the neobanks have made a number of process changes that make it easier for people to refinance. There’s now much less need to have to contact a mortgage broker, go into a branch or see a banker to negotiate a new loan.

Hyman says more people are taking advantage of the stay-at-home edict to refinance. “Between mid-March and mid-April this year, we saw a 40 per cent increase in owner-occupiers refinancing compared to the same time last year. So people are definitely voting with their feet and taking matters into their hands, which is great. But obviously, there’s many more who should be doing the same.”