A recent ACCC report on the residential mortgage pricing of five major banks between 9 May 2017 to 30 June 2018 found that opaque discretionary pricing inflated borrowers’ costs (including their time and effort) to discover better offers, directly impacting their enthusiasm to shop around. Due to the perceived high cost of price discovery, 70% of borrowers surveyed obtained just one quote before taking out a mortgage and existing borrowers paid, on average, interest rates up to 32 basis points higher than new borrowers.
How does Discretionary Pricing Work?
The headline interest rates advertised by Inquiry Banks used to attract residential mortgage borrowers are generally a poor indicator of the interest rate borrowers actually pay.
Typically there are two types of discount offered by residential mortgage lenders:
- Advertised discounts, that are generally published on a lender’s website and are relatively easy for borrowers to discover.
- Discretionary discounts, that are offered by each Inquiry Bank based on criteria that are not disclosed to borrowers (i.e. on a case-by-case basis after an individual’s application has been assessed).
The level of discretionary discounts offered by each Inquiry Bank is based on criteria that vary across lenders and over time, some of which have included:
- the borrower’s individual risk profile, taking into account income, total assets and liabilities, and creditworthiness
- the geographic location of the residential property and the LVR
- the borrower’s value or potential value to the bank, taking into account their total borrowings with the bank and willingness to take up other products
- the bank’s desire to write new business.
Price Considerations When Choosing a Lender
Price is an important consideration for many borrowers when choosing a lender or if considering to switch, although some borrowers require a significant price difference before they would consider switching. The findings from surveyed borrowers were:
- Lower interest rate from another lender. The most common ‘initial trigger’ for switching lenders was another lender offering a lower interest rate. 67% of borrowers surveyed ultimately switched to another lender because that lender offered a lower rate.
- Dissatisfaction with the current rate. Those likely to switch from their bank in the next 12 months were considering this due to dissatisfaction with their interest rate, the proportion rising from 48 percent in March 2013 to 66 percent in December 2017.
- Interest rate at least 60 basis points lower. Nearly one-third of current borrowers surveyed said they would not consider switching unless the offered rate was at least 60 basis points lower than their current one. While another third would switch for an interest rate up to 59 basis points lower.
- The four most important reasons for borrowers’ selection of a mortgage lender were the interest rate, followed by monthly fees and ‘product fits needs’ equally, followed by loan application fees.
Non-Price Considerations When Choosing a Lender
Sometimes price is not the main consideration for borrowers when choosing a lender or whether to switch to another lender. Non‑price reasons include:
- Prefer to remain with the existing lender. In a survey from December 2017, the top two reasons current borrowers chose their mortgage product was because the lender was their main financial institution for their personal banking, and to get the most competitive interest rate.
- Certain product features. One survey from March 2018 asked borrowers what the most important factors were in choosing their residential mortgage product, aside from interest rates. The top two reasons, each identified by one in six borrowers, were ‘ability to make overpayments’ and ‘100% offset account’.
- Overall customer service. One survey conducted in December 2017 asked borrowers who had switched their mortgage to another lender what their key reason was. Nearly one in seven identified ‘my lender had poor customer service’ as their key reason.
New Borrowers Pay Lower Interest Rates Than Existing Borrowers
Existing borrowers who do not actively shop around for a better deal on a regular basis are the main losers from opaque discretionary pricing. They have paid interest rates at the Inquiry Banks that were up to 32 basis points higher on average than those paid by new borrowers, as at 30 June 2018.
What Borrowers Can Do to Get a Better Deal
There is more intense competition for borrowers who are actively engaged and well informed in their choice of a residential mortgage. Borrowers can:
- ask their current lender for a better interest rate and lower fees on their residential mortgage
- switch their residential mortgage to a cheaper product with the same lender
- switch lenders
- contact a Mortgage Broker to complete a review for them
Borrowers should review their residential mortgage products on a regular basis, ideally annually, to ensure they are getting the best possible price. Even a 10 basis point reduction in the interest rate paid on the average new residential mortgage will save borrower thousands of dollars in interest over the life of that residential mortgage.
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Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.