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May 12

Interest Rates – Small Differences, BIG Impact!

There’s a lot to consider when working out the best loan for you. The obvious comparison is the interest rate, and this is where most Australians start and stop in their comparison. But for most Australian borrowers, there’s more to the story.

Don’t let application, annual or exit fees divert your attention from the main game – overall savings in your pocket instead of the bank’s!
When it comes to comparing home loans, understanding how much impact small differences in interest rates have is absolutely the key to getting on top of your home loan.

To illustrate this, let’s take a typical mortgage of $300,000, and compare two different interest rates.

First, there’s a variable rate of 6.69 percent (let’s call this Bank A), one of the lowest on the market. We’ll compare that to the standard variable rate from Bank B at 7.80 percent.

The difference between the two in monthly repayments is significant — $216 per month extra from your pocket for Bank B every month (we could think of far more enjoyable things to do with that money every month than pay the bank!). But the real difference is in the lifetime cost of repayments. Over the life of the loan, assuming that the difference between the two rates stays the same, you’ll have paid around $65,000 less to Bank A for your loan. This is where the “magic of compound interest” really kicks in.

The difference between the two rates is 1.11 percent. The best way to think about that difference is this: every month that you have that home loan, every single dollar you owe costs 1.11 percent more per year from the Bank B loan compared to the Bank A loan.

Now when you look at up-front fees, Bank B is actually cheaper: $600 versus $825 for Bank A. When you’re saving for a deposit and moving costs, $225 isn’t trivial, to be sure. But when you look at the difference in total repayments because of interest rates, it’s tiny. In fact, the saving in up-front fees is less than 0.5 percent of the difference in repayments!

By contrast to upfront fees, annual or ongoing fees are a different story — because they happen every year, small differences in one year can add up to big differences over 25. Look closely at the ongoing fees and make sure you’ve compared home loans accurately on this score.

There are lots of features in home loans apart from rates and fees that you should look at, but start by comparing the interest rate and the ongoing or annual fees that you’ll get charged. All else being equal — and I know that’s a big “if”! — a home loan with lower interest rates and lower ongoing fees is going to be better for most borrowers.

Interest rates and annual fees are the things that stick around for the life of your loan, and comparing home loans on these grounds is the best way to look after your long-term interests. So by all means, cheer on the banks when they promise to reduce or cut their fees for home loans. A dollar in your pocket is generally a better thing than a dollar in a bank’s pocket — but don’t fall for the trap of thinking that fees are the be-all and end-all.

When surveying our clients recently, many used the term ‘minefield’ in response to the task of finding the right loan. But it doesn’t have to be this way. Call in an expert, and the guess work is instantly taken out.


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