Written by James Hall for news.com.au
Australians wanting to get ahead on their home loan repayments have been dealt a blow, with lenders significantly reducing the amount borrowers can pay on top of their regular instalments.
When RBA governor Philip Lowe cut the official rate to 1.0 per cent in July, the lowest in the country’s history, homeowners with mortgages were able to save thousands of dollars by paying off their loan faster and with less interest.
But those with a fixed rate have been told by their lenders the maximum they can repay per year has been cut by thousands as the banks limit their losses on loan costs.
St George Bank customers were previously able to pay an added $10,000 per year on their mortgages without being hit with a financial penalty.
Last month, however, the lender told those with a five-year deal this would be cut to $30,000 over the life of the fixed rate period — meaning the maximum the borrower can now pay is $6000 a year.
“People do have to be aware that if they think they can put more into their loan and would like to knock it off earlier, then you might be restricted if you have a fixed-rate loan,” Canstar group executive of financial services Steve Mickenbecker said.
“We always say to people to get ahead on your home loan, it’s the best thing you can do for your financial future — repay early.
“But if you have a fixed-rate loan, you’ll be up for a significant penalty if rates have gone further down.
“The penalty isn’t a fee, it’s the economic cost to the bank in allowing you to repay early and it relates to the fact the bank will have a three-year deposit they have to pay interest on.”
Extra repayments for fixed-rate home loans. Table: CanstarSource:Supplied
WHY DO BANKS DO THIS?
For banks to mitigate the risks of locking into a set rate, they raise a deposit they have to pay interest on over the life of the deal with a fixed borrower.
As St George told its customers, the risk associated with movements of interest rates is accepted by the bank.
“We then manage this risk based on the understanding that all the required repayments due over the whole of the fixed-rate period will be made in full and on time,” the bank said in document to its customers.
“We obtain funding on this basis through transactions at wholesale interest rates.
“If you make a prepayment or change to another interest rate or product or another repayment type, that will change our funding position.
“If wholesale market interest rates have dropped, this causes a loss to St George. The estimated amount of this loss is passed on to you as a break cost.”
THIS SOUNDS SNEAKY?
Mr Mickenbecker told news.com.au it was not sneaky because it was essential for the bank.
“Because they’re not gambling on rates, they are matching it so they’re entitled to say ‘you’ve got to match your repayments’,” he said.
“It’s one of the things prudent lenders have to do … there’s nothing sneaky about it, but a lot of people might not be aware of it.”
The finance expert says it gets tricky when borrowers suddenly come into a windfall, such as through an inheritance, and are unable to put a dent in their loan without paying a penalty, which can be up to $20,000.
He said it also becomes costly when the borrower comes into financial hardship or a relationship breaks down and the house needs to be sold quickly.
“It’s going to mean you can’t necessarily get way ahead (with repayments),” Mr Mickenbecker said.
Mr Mickenbecker says to consider pre-GFC days as a cautionary tale when deciding whether to fix your loan.Source:Supplied
TO FIX OR NOT TO FIX?
With interest rates at the lowest they’ve ever been, Mr Mickenbecker says a fixed rate is a good option but hold off for another few months.
It’s widely expected Dr Lowe will cut rates into the new year, so it’s wise to wait until the dialogue switches to lifting rates.
“I don’t think people need to rush into the market and fix right now, but I think it should be on people’s consideration some time in the next six months,” he said.
Borrowers who locked into a fixed rate before the global financial crisis (GFC) should be considered as a cautionary tale, Mr Mickenbecker said.
The official rate peaked during that period at 7.25 per cent in August 2008 and tumbled to 3.00 per cent by April 2009, meaning anyone with a fixed rate was paying significantly higher than the market price.
“People have this inclination to act when they’re filled with fear and they’ve taken so much pain with interest rates going up repeatedly,” he said.
“This is where the mistake is made because typically people start fixing at the top of the cycle and find themselves locked into something huge.
“It meant that in the lead-up to the GFC people found they were paying way above what they should have been paying six months later.
“That was a huge break fee because interest rates fell off a cliff.”
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