You could be forgiven for thinking that interest rates occupy our minds more than any other topic. Every time a bank moves rates one way or another, it’s headline news. Even when the RBA doesn’t move rates there’s a news story about it. We’ve been conditioned to think that when you’re considering or already have a loan the most important factor for you to consider is the interest rate that you pay. If it is, it shouldn’t be.
Continually thinking about interest rates can lead to mortgage stress. I’ve written a couple of articles about this some time ago. You can access those articles here and here. Note that I’m not a mental health professional.
Let’s look at the different types of borrowers and whether or not – in our experience – Interest rates are that important to them.
First Home Buyers
When this demographic is looking for their first home loan the most important factor occupying their minds is whether or not they will get a loan at all. Sure, interest rates are important but useless if they can’t get a loan. We’ve seen a few couples come in after failing to get a home loan by approaching a bank themselves. How did they choose the bank? It was the one with the cheapest interest rate. Fail. In almost all cases we’ve been able to secure finance.
Commercial Loans
Here’s the area – you would think – that interest rates would be of primary importance. Again, no. Businesses are just grateful to get a loan at all these days as lenders’ policies have tightened up so that lending to all but the most creditworthy has dried up. In many cases, interest rates aren’t even discussed.
Leasing
The least important factor in a lease (like a car lease) is the interest rate (within reason). What people are most interested in is monthly repayments. This can be manipulated by two other components of a lease (assuming the price is set). They are the term of the lease and the residual value. An example? Of course. The below example shows a car being purchased on a lease. The price is the same and the interest rate is higher for the second column but the monthly repayments are cheaper.
| Principal | $50,000 | $50,000 |
|---|---|---|
| Term (years) | 3 | 4 |
| Interest Rate | 5% | 10% |
| Residual | $20,000 | $22,500 |
| Monthly Repayments | $982 | $885 |
Why? Look at the residual values and the term of the lease. We’ve gone an extra year and despite the interest rate being double that of the first column, the monthly repayments actually come in cheaper. We don’t advocate paying double the rate, we’re just using an extreme example to illustrate a point. So next time you see a car advertised with really low rates you know that it makes very little difference to your monthly repayments.
SMSF Loans
For lending against residential property, these borrowers pay around 1.2-1.5% above the current home loan interest rates. Obviously, interest rates are not of paramount importance to them. They want to buy in their super funds as the cash in the funds is earning them 2% with no hope of capital gain.
Refinancers
Now these borrowers are very well researched. Interest rates are important to them. Some come in thinking that the advertised interest rate that they see on line is available to them and in some cases they are. What they don’t realise is that in many cases the cheap interest rates advertised on line don’t include all the bells and whistles that they may have with their current loans. Such as, offset and redraw. Some people, who have a line of credit, think they should be eligible for these discounted interest rates. They’re not. A line of credit or equity loan is usually priced at between 0.50 – 1.00% above these cheaper rates.
Upgraders and Investors
Those that have purchased a home before know what to expect. Except, they really don’t. Home loans have changed so much in the last 5 years and people are not expected to keep up with the changes. It’s these people who are most likely to use a mortgage broker as they know what a dog’s breakfast borrowing can be. They just want it all done for them and they know they will get a comparison of twenty plus lenders and can choose a loan based on interest rates and whatever other factors that they deem to be important to them.
If interest rates are important to you remember that we’re lucky enough to live in an era of very low interest rates. What has that done? That’s another article.