Loyalty tax: Is there such a thing when it comes to home loan interest rates?

Loyalty tax: Is there such a thing when it comes to home loan interest rates?

All lenders set the margins they want to make when lending money. In many ways, lenders are not that different from businesses like Coles and Woolworths. Just like supermarkets run promotions and discount products to attract customers, lenders often offer discounted interest rates to win new business.

Unlike Coles and Woolworths, however, a lender has limited ways to discount its products. The primary tool available is reducing the interest rate it offers, which directly impacts its profit margin.

To offset the loss of margin on new business, often referred to as the “front book” in the finance industry, some lenders (not all, and not all the time) will reprice their “back book”. In simple terms, this means increasing rates for existing customers to recover some of the margin they are giving away to attract new borrowers.

A lender’s back book consists of its existing customers. Repricing means increasing interest rates for certain existing borrowers, and this can happen in several ways.

Sometimes lenders wait for the Reserve Bank of Australia (RBA) to change the cash rate. For example, if the RBA reduces the cash rate by 0.25%, the lender may only pass on part of that reduction. As a result, the lender immediately increases its margin.

Conversely, if the RBA increases the cash rate by 0.25%, a lender may take the opportunity to increase its variable rate by more than 0.25%, again increasing its margin on existing customers.

In some cases, lenders may simply increase their variable interest rates outside of any RBA cash rate movement.

This is one of the reasons I conduct an annual rate review for my clients. Each year, I approach their lender and request a pricing review with the aim of securing a lower interest rate.

Lenders collect an enormous amount of customer data. When either I or the customer contacts the lender and requests a discount, the lender will often perform an internal assessment to determine the likelihood of that customer refinancing elsewhere if the request is declined.

Some lenders reportedly assess more than 150 different data points when estimating the likelihood of a customer leaving. They have learned that the more products a customer has with the institution, the less likely they are to refinance away, even if they do not receive the discount they believe they deserve.

When I refer to products, I mean services such as credit cards, offset accounts, budgeting tools within internet banking, and other banking services. Lenders may also consider how frequently you use online banking and how often you engage with the institution.

Lenders know that the more integrated you become with their products and services, the less likely you are to leave. As a result, they may not feel compelled to offer you their most competitive interest rate. Instead, they may provide a modest discount, just enough to make you feel valued and remain a customer.

Lenders are also aware that refinancing takes time, effort, and often incurs costs. Because of this, they know they do not necessarily need to offer their very best rate to retain your business. They simply need to offer enough value to keep you satisfied.

Final Thought

Many homeowners assume their lender will reward loyalty with competitive pricing. Unfortunately, that is not always the case. The reality is that some borrowers who regularly review their home loan and negotiate their rate may end up paying less interest than long-term customers who simply stay put.

That’s why it’s important to review your home loan regularly and ensure your interest rate remains competitive. Loyalty is valuable, but when it comes to home loans, it pays to verify that your lender values that loyalty as much as you do.