What is the loyalty tax?
Loyalty tax is a tax on loyal bank customers. It refers to the higher interest rates paid by existing home loan customers compared to new customers.
It is not a tax in the traditional sense, but rather a premium paid by existing customers.
The difference in interest rate paid exists because banks offer larger discounts to new customers compared to the lower discount offered to existing loyal customers.
As one of the big four banks put it, ‘switching banks is a pain – we shouldn’t need to beat a competitor on price to retain a customer if they are happy with our service’.
How big is the loyalty tax for home loans?
The average difference in interest rates paid by new and existing variable rate customers was 0.26% as of September 2019, according to a 2020 report by the Australian Competition and Consumer Commission (ACCC).
This difference increases the longer you stay with a lender. For example, the report found that customers with existing owner-occupier loans with principal and interest repayments which were greater than five years old were, on average, paying 40 basis points or 0.40% above what new customers paid.
That means a customer willing to switch lenders with a $400,000 loan (P&I) can save up to $1,592 in the first year alone, and $30,843 over the life of the loan (calculation based on switching 3.1% p.a. to 2.7% p.a. on a 30-year P&I loan term).
How do I avoid paying the loyalty tax?
The only way to avoid paying the loyalty tax is by shopping around and negotiating with your lender.
Existing home loan customers have two options before them, namely:
- Requesting a lower rate: Customers may be able to obtain a lower rate on their current loan simply by calling their bank or mortgage broker. Look at interest rates offered to new customers by your lender as well as a few competitors. Then contact your lender and tell them you’re paying too much. If they don’t offer you a decent rate, go somewhere else.
- Refinancing: By refinancing to a new loan or a new lender, customers can take advantage of larger discounts which are usually not available for existing loans.
Requesting a lower rate
While not all customers will be eligible for a discount, customers willing to ask for a better rate often get these discretionary discounts.
These discounts can go up to 1.7% off the Bank Standard Variable Rate.
When you make a pricing request the banks will look at your loan amount, repayment history (mortgage conduct), and the loan to value ratio (LVR) and their computer system will generate a discount for you in that range.
If you’re unhappy with the discount rate, you can usually escalate the matter with the bank negotiating for a more significant discount. Their pricing department will then do a manual assessment and get back to you with a final discount rate.
They often match the rates offered by a competitor but not always.
If they can’t or won’t match the rates available to you through other lenders, then refinancing is your best option.
Case study: Negotiating with your lender pays off
One of our customers Dave had a home loan fixed at 3.83% p.a. which was expiring in a week’s time.
Dave wanted to switch to a variable rate and get the best rate for himself.
First, we applied for a price reduction (pricing request) and the bank came back with a discounted variable rate of 2.94% p.a.
However, after looking at the rate offered by another bank who was willing to refinance Dave’s home loan at 2.69% p.a., we escalated the pricing request and asked them to match the offer.
After a manual review by their pricing department, they agreed to match the offer “as an exception for retention purposes”.
The problem with price reductions (pricing requests)
The main issue is that the discount offered to customers seeking price reductions is not as large as discounts offered for new customers.
For example, if we take the average of the standard variable rate of the big four banks which currently stands at 4.79% less the max discount of 1.7%, your new interest rate will be 3.09% p.a.
When you consider that there is currently a price war between lenders for new customers with interest rates in the 2% range (as of this writing) this difference becomes even wider.
So, it is generally advisable that you consider refinancing every 3-4 years to take advantage of lower interest rates.
Why aren’t more people refinancing?
Refinancing seems like the logical choice but why are customers preferring to remain with their existing lender and get a smaller price reduction compared to what they could get by refinancing?
There is the initial cost of refinancing and perhaps, more importantly, the non-monetary costs associated with switching lenders.
The initial cost of refinancing is minimal compared to the thousands of dollars that you may potentially save on interest and other fees over the life of the loan period.
Besides, these costs can be offset by the numerous refinance cash back offers currently on offer.
The primary roadblock seems to be that customers do not have the inclination to spend time and effort to make the switch.
Refinancing isn’t as complicated as it used to be plus you have already been through the process when you first bought the property. This time there is no contract of sale to go through, no solicitors and real estate agents to talk to, just your bank or your mortgage broker.
Avoid paying the loyalty tax
If you’ve been with your bank for more than 3 years, you’re likely paying too much.
Shop around, and negotiate with your bank – you could be a few thousand better off because of it.
If your bank won’t match an offer, talk to one of our specialist mortgage brokers by giving us a call on 1300 889 743 or by filling in our online assessment form.