What is loyalty tax and how do you avoid paying it?

Picture this scenario. You’ve reached the front of the line at your favourite cafe and happily pay $4 for your flat white. But then the next customer places the same order and is only charged $3. Turns out this is a new customer and the cafe is keen to win their business with lower prices. Sounds a little unfair, right? You’ve been a loyal client for years, and your loyalty is rewarded with a premium coffee price.

While this scenario doesn’t typically unfold in cafes, it does unfold on a daily basis at banks and loan providers across the country.

It’s called the loyalty tax –the premium you pay for sticking with one lender when that same lender is offering a lower interest rate to its newest customers.

Am I paying a loyalty tax?

Domain Home Loans chief executive Kareene Koh says customers who have been with one lender for some time will assume their loyalty will be rewarded with a competitive rate, but that often isn’t the case. 

“The longer that you’ve been on a loan or package the more likely you are to be out of sync with the market in terms of the rate that you’re paying, particularly if you’re on a variable rate,” she says.

“If you’ve been with the bank for more than four years, then it’s likely that you’re paying a loyalty tax.”

There could be as many as eight million Aussies paying a loyalty tax, according to a report released by financial product comparison website finder.com.au.

Finder’s head of consumer research, Graham Cooke, points out that while it seems counterintuitive, consumers who stay loyal to one provider for many years can be the ones who miss out on the good deals and the opportunity to make significant savings by changing lenders.

How can I avoid paying a loyalty tax?

Koh says the only way to avoid paying the loyalty tax is to keep up to date with current interest rates and, if your lender won’t match the best loan offers, consider refinancing.

“A really good practice is to make sure you’re doing a home-loan refresh on a regular basis, for example when you’re coming up to the end of a fixed-rate period,” she says. “I’d really recommend people start turning their minds to it six to eight weeks before that happens so that they have time to shop around and, if they need to change banks, they have ample time to do that.”

For those on a variable rate, Koh suggests checking in with your broker regularly to ensure you’re familiar with the options available to you as the market and interest rates shift. 

“It may turn out that customers are on the best package for them but it can’t hurt to chat to a broker and just check that the package you’re on is still right for your personal needs and situation and that there isn’t a better deal out there for you,” she says.

Should I refinance?

A record 331,976 property refinances were recorded across Queensland, NSW and Victoria in the 12 months to June 2022 – up 29 per cent on the previous 12-month period – says PEXA head of research Mike Gill.

“In the current environment of rising interest rates, record numbers of homeowners have decided to refinance their home loan, with many opting to switch lenders,” he says. 

Gill anticipates the refinancing trend will continue if rates rise further. 

“Household budgets are under pressure from the effect of both increasing mortgage repayments and the rising cost of living due to inflation,” he says. 

Koh reminds borrowers that brokers don’t charge for their service, so it’s well worth seeking their advice on whether a refinance is right for you.

“There’s absolutely no harm in people having a conversation with a broker,” she says. “In terms of costs to transition from one loan to another, that can vary from bank to bank.

“If in doubt, I really encourage people to ask questions. It’s absolutely OK to push for more information to make sure you really understand the terms of the loan, the fees you’re signing up for and what the features of the different products mean.”

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Will refinancing be problematic?

Koh is aware of two key fears that tend to discourage people from refinancing.

“People are scared if they go through the process [of refinancing] and for some reason it’s not successful that they’ll be penalised by their bank … that’s not the case,” she says. “There’s absolutely no harm in shopping around.

“The other thing we often hear is people think it’s a lot of work and they can’t be bothered with the admin. The reality is, if you look at the numbers and you can be saving $2000 a year, can you really not be bothered saving $2000 a year?

“The benefit of a mortgage broker is that you don’t pay for their service and they do most of the work for you.”

Koh urges people to take control of their finances and shop around to avoid the loyalty tax. 

“Don’t be a passenger on something that’s as important as your home loan,” she says. “Over the life of the loan, $2000 a year over 20 years is a material sum of money and well worth thinking about.”