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What is a reasonable interest rate?

ByAndrew Mirams

There’s a very good chance that you’re paying too much interest on your home loan.

That was the declaration earlier this month from Australian Competition and Consumer Commission boss Rod Sims, after the agency conducted an inquiry into mortgage rates.

Essentially, it found that long-term home loan customers with the major banks are paying an average of 0.26 per cent more in interest than new mortgage customers. It’s what has been referred to as a ‘loyalty tax’ – the longer you’re with a lender, the more you’re likely to be paying.

For those customers who’ve had a mortgage for more than five years, the average amount of higher interest paid swells to 0.4 per cent.

And while a fraction of a percentage point doesn’t sound like much, it’s thousands of dollars per year that you’re parting ways with unnecessarily.

What should you be paying?

We know that the Reserve Bank’s official cash rate is at its lowest level ever, falling to just 0.25 per cent earlier this year.

This, coupled with intense competition among lenders, means home loan interest rates are extremely good at the moment.

Home Loan

I’ve done some analysis of the various rates on offer across a range of products, for a number of different scenarios, to determine just what is a reasonable interest rate right now. If yours is different, I strongly encourage you to consider refinancing.

If you have a mortgage on your principal place of residence and you’re paying both principal and interest, your current rate must start with a two. Anything higher and you’re paying too much and foregoing some significant savings.

Just think, the average above of 0.26% on a $500,000 home loan equates to $1,300 per annum OR $108 per month and I’d much rather that in the pockets of all my clients than the banks!

Let’s say your mortgage for your home is interest only. That rate should start with a three and be in the lower range of that percentage point.

For investment properties, the rates tend to skew a little bit higher than for principal place of residence mortgages. But still, there are some enticing deals and offer and if you’ve been a customer for a while and haven’t refinanced recently, chances are you’re paying too much.

For an investment loan where you’re paying both principal and interest, your rate should be in the high range of two per cent to the low range of three per cent. 

If you’re paying interest only on your investment mortgage, the interest rate should be in the low to mid three per cent range.

In fact the savings here are much larger, as a rule, than the average 0.26%. We recently undertook a study on the average rate savings we’ve made for our investor clients over the past year and it came out at a whopping 0.64%. Yes, that’s right.

And for that $500,000 investment loan, a saving of 0.64% comes to an annual saving of $3,200 or $267 per month. Just think what you could do with that?

If your rate is higher…

Refinance. I can’t be clearer – if your current mortgage interest rate for your circumstances is higher than what I’ve mentioned above, call me.

You might think it’s a huge effort but, in the scheme of things, it’s not. Working with an advisor takes a lot of the stress and hoop-jumping out of the process.

And it’s worth it, regardless. Let’s say the rate you signed up for is 4.5 per cent and you haven’t had it adjusted in the several years since, you’re probably forking out at least $400 a month. That’s money that you could put towards reducing your loan size, easing your household cost of living or investing to build your wealth.

Don’t let complacency cost you thousands of dollars a year. The bank doesn’t need it!

First home buyer New

What about fixing?

When it comes to fixed rate mortgages, there are some historically low rates on offer at the major banks and second-tier lenders right now. If you’re considering fixing to lock in savings for the mid-term and give yourself some certainty about your outlays, you should accept a rate that has a two in front of it. 

In my analysis, that’s where those fixed products tend to be falling and anything more than that is a lost opportunity.

Of course, whether or not you decide to fix your rate depends on a number of factors and it’s crucial that you seek guidance from an independent, properly qualified and very experienced advisor. 

Your personal circumstances right now, as well as in the mid-term, are worth considering, as is your goals. Fixed rate products lack a lot of the features of variable rate home loans, such as an offset account. You also sacrifice a lot of flexibility, like early repayments or discharging your mortgage without hefty financial penalties if you sell.

Andrew Mirams
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