Interest rate cut relief for home owners
The Reserve Bank's 0.5 percentage point cut in interest rates presents borrowers on variable rate home loans with a golden opportunity to make inroads into their mortgage.
The chief executive of RateCity, Damian Smith, advises people on variable rates to maintain repayments at the old, higher rates and pay off the mortgage sooner.
''It's the best financial decision that they could make on a non-tax-deductible investment such as the family home,'' he says.
There are about 1.1 million households who make only the minimum repayment on their mortgages, he says.
Many of these will be tempted to pocket the rate-cut savings to help with living expenses.
But where borrowers can maintain the higher repayments, it is an opportunity to make interest savings and shorten the loan term.
Someone with a $300,000 mortgage over 25 years paying 7.25 per cent would save $68,000 in interest and shave two years and eight months from the loan term, if repayments were maintained and the lender passed on the full 0.5 percentage point cut, says a spokeswoman for Mortgage Choice, Belinda Williamson.
Smith thinks this is unlikely and expects lenders to pass on 0.35 percentage points, on average.
The Bank of Queensland has cut its standard variable rate by 0.35 percentage points to take its variable home loan rate to 7.11 per cent. NAB has cut by 0.32 percentage points to 6.99 per cent, CBA by 0.4 percentage point to 7.01 per cent and Westpac by 0.37 percentage points to 7.09 per cent. ANZ will announce any change on Friday.
Prior to the rate cut, the standard variable rate of the big banks was about 7.4 per cent. Lenders tend to discount that for customers (especially if they ask), bringing the rate to just under 7 per cent.
By having more money going into the mortgage than the minimum repayment, mortgage holders are effectively earning an interest rate, after tax, of 7 per cent.
''You would need to earn at least 9 per cent on another investment on which tax would have to be paid to be ahead,'' Smith says. Many people have their pay deposited into a savings account earning a pittance that is eaten away by tax on the interest.
A senior mortgage broker at Aussie, Lindsay Rogers, says borrowers should not make assumptions about whether or not their lender will adjust the repayment amount in the event that the lender cuts rates.
While some lenders will leave the repayment level the same if the minimum repayment falls, others will reduce the repayments to the new minimum, he says.
''It's always a good idea to ring the lender and say you want to leave the repayment on the current level,'' he says. Having salary paid directly into an offset account linked to the mortgage is a powerful way to reduce the loan term and save interest, Smith says.
The salary in the offset account reduces the mortgage balance on which the interest is calculated. The money accumulated in the offset account can be withdrawn at any time if you need it.
Smith says another benefit of having salary go into an offset account is that the chance of missing a repayment is reduced. The all-to-regular outages and glitches of online banking sites can cause customers to be late with their mortgage repayments.
Salary paid straight into an offset account will not remove the risk - an employer's bank may have a glitch and the pay may not go into the offset account in time - but the risk is minimised.
Rogers says just because a lender has reduced the interest rate on a mortgage does not mean borrowers should be content to stick with that lender. ''Even though your interest rate might reduce, it is a good time to have a look at what others are offering,'' he says.
Many people are getting discounts on advertised rates. He says those with larger mortgages and lower loan-to-valuation ratios (LVRs) are in the strongest position to negotiate a discount.
Rogers says anyone with a loan size that is less than 75 per cent of the value of the house, even if their loan is small, should be able to get a discount because they are a lower risk to the lender.
Borrowers should also consider fixed-rate mortgages, Rogers says.
These are good at the moment, with some lenders offering under 6 per cent on their three-year fixed-rate mortgages. ''Anything under 6 per cent is a great rate,'' he says.
Most economists are expecting another rate cut of 0.25 percentage points, with perhaps one more 0.25 point cut in the next 12 months. How attractive would a three-year fixed rate be then?
Assuming lenders pass on 70 per cent of the cuts over the year, that would take the average standard variable rate of the big banks to 6.7 per cent from 7.4 per cent. If you also include the 0.5 percentage point discount, the discounted standard variable rate may fall to 6.2 per cent. On that basis a three-year fixed rate of less than 6 per cent could be a good option.
But views on interest rates can change. They are notoriously very difficult to forecast.
Borrowers also need to take into account the restrictions fixed-rate mortgages have, such as limitations on making extra repayments.
They usually don't have a redraw facility (which allow borrowers to access the extra repayments they have made) and there could be costs involved in terminating the loan early. Rogers advises borrowers who are unsure about the direction of interest rates to explore splitting their mortgage 50/50 between variable rate and fixed rate.