Paying the mortgage is the largest expense for many households, which is why personal finance gurus are constantly reminding us of how much can be saved by shopping around for home loans.
As interest rates rise, this is more relevant than ever. Banks have been quick to pass on official rate rises in full to their existing customers, while offering better deals for new borrowers or those who threaten to switch. Put another way, the penalty you pay for being a long-term loyal customer has grown.
So, it seems an appropriate time for policymakers to turn their heads to home loan pricing once more, and whether this expanding “loyalty tax” is a good outcome for consumers. Is there more we could do to get people to act in their own interest, and seek out cheaper loans?
Credit:Matt Davidson
The Australian Competition and Consumer Commission (ACCC) looked at this exact issue in 2020, though its recommendations were never acted on by the former federal government. Some smaller competitors to the big four are now wondering why. It’s a fair question.
Almost two years ago, the ACCC published a report confirming that when it comes to home loans, loyalty doesn’t pay.
The watchdog said existing customers typically paid interest rates that were about 0.25 percentage points higher than those paid by new borrowers, and the longer you stayed with a bank, the bigger this gap became. For the typical borrower, these kinds of differences add up to thousands of dollars over the longer term.
To deal with the issue, the ACCC said lenders should be required to give borrowers with a loan that was written more than three years ago an annual prompt encouraging them to see if they could get a better deal in the market. This would act as what behavioural economists call a “nudge” – a suggestion that people do something sensible, without forcing them to do it.
The ACCC also recommended changes to make it easier to dump your bank: a standardised mortgage discharge form and a 10-day limit on how long it takes to discharge a loan.
The Morrison government didn’t formally respond to these recommendations (federal Treasury says governments are not required to issue a formal response to ACCC price inquiries). And to be fair, there was plenty happening in late 2020, when banks were fretting over a wave of bad loans caused by the pandemic.
Even so, the home loan loyalty tax has only risen since late 2020, thanks to interest rate rises and competition between banks for new business.
Since the Reserve Bank started raising rates in May, banks have quickly passed on the 2.5 percentage points of rate rises to existing customers in full, while offering a better deal to new clients, who banks lure with lower rates or cash payments worth thousands of dollars. According to the mortgage broker Finspo, the gap between the rates paid by existing customers and new customers has blown out to a record 0.48 percentage points.
Is this widening gap between the rates that different groups of people pay on their loans a problem? And if so, what could be done about it?
Banks have long claimed there’s nothing much to see here – they basically say it’s a reality of capitalism that if you want a better deal, you need to shop around. That is true at a superficial level, but sorry, it’s not that simple.
As interest rates have risen, banks have been offering the best deals to new borrowers.Credit:Peter Rae
The ACCC clearly thought it was a problem. It said that unlike other markets, mortgages were “opaque” because no one actually pays the advertised interest rates, making it hard to know if you’re getting a good deal.
Former ACCC chairman Rod Sims, who is now a researcher at the Australian National University, says: “The mortgage market is about as non-transparent as any market gets. You just do not know what other people are paying for interest on their mortgage.”
In response, the regulators have been trying to give people more information. The Reserve Bank in the past few years has been publishing data on the actual interest rates people pay on their mortgages, compared with those offered to new customers. There’s also an industry of mortgage brokers, comparison websites, and other fintechs that make money from encouraging people to switch banks.
This is all probably helping. More people appear to be getting the message about shopping around – that’s one reason refinancing has hit record highs lately.
The data-sharing regime known as open banking may eventually help too, because it would allow people to more easily share their financial information with a rival lender. However, data-sharing has been painfully slow to get moving.
With household interest costs rising – and major bank profit margins tipped to rebound sharply – the ACCC’s 2020 recommendations on removing barriers to switching and “nudging” still look relevant.
The idea of giving people a “nudge” is a growing trend in global regulatory circles, with federal and state governments setting up teams to advise on behavioural insights in recent years.
Some banks have their own behavioural economists, and all lenders face growing pressure from regulators to make sure people are not in unsuitable products. The corporate watchdog, for instance, last week flagged a project aimed at improving outcomes for credit card customers, and Commonwealth Bank last year trialled a feature to give people a “nudge” to pay back credit card debts when they receive a tax refund.
Applying similar nudges to encourage customers to consider refinancing would no doubt be more complicated. But it could help to keep banks under pressure to offer competitive interest rates to existing customers, not just new borrowers.
Ross Gitins is on leave.
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