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Why are home loan rates different for new customers?

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We get down to the tough topic of why lenders are able to offer different rates to new customers that don’t always match what an existing customer has.

It’s a topic that seems to be a big pain point for most of us with a mortgage, and for good reason too. The business of lending money can be a little complex and a lot goes on behind the scenes of you getting a home loan.

So we’re going to tackle the question of “Why are home loan rates lower for new customers?” and closely followed up with an understanding of “Am I really getting ripped off or not?”

Where does the money we borrow come from?

Did you know that when we borrow money for a home loan that it’s not just sitting around somewhere? Have you stopped to think about where the money comes from? Unfortunately, it doesn’t grow on trees (though let’s be honest – we all want that to be a real thing!).

Almost every lender who lends money to you, borrows it from somewhere. Let that sink in for a bit…

“when we borrow money from a bank, they borrow that money from someone else too.”

It’s not something that we think about in our day to day lives, but I know that if you work in finance (particularly lending), you think about it all the time.

So what’s that got to do with me? I just want a home loan!

Everything actually!  This concept is what forms a big part of how your home loan interest rate is calculated and why new customers can get a better deal.

When you decide that you want to get a home loan, what it costs the banks to borrow that money is locked in.  When you settle, your loan is “allocated” to whatever source the bank borrowed money from and this is often part of what is referred to as the cost of funds.

Every time you make a home loan repayment, the whole amount doesn’t just sit with the bank in a big pile of cash (though many media outlets would have us believe that).  It goes towards them paying back the interest that they have to pay on the loan that they borrowed in the first place to give to you…..phew, that’s a lot of words.  So; you pay bank.  Bank pays investors.  Pretty simple.

OK, so where does the money come from?

There’s a lot of places that money comes from when you’re dealing with a bank.  Almost all of it is “borrowed” in some way (it’s not the right technical term, but it works for our analogy without getting into a uni course on the subject).  That can be from shareholders investing and expecting a return, your savings accounts known as deposits, bank balance sheets or bonds amongst other things.

Overall, lending for home loans takes a lot of money.  I mean lots.  Australia is now totalling into the TRILLIONS lots of money.

When we all chip in a few thousand dollars in our savings account, it’s going to take a lot of us to get to the billions of dollars in home loans that are made every year right? So that’s where other parties come into it. It’s not just deposits, but also superannuation funds, institutional investors (big businesses globally who operate in the capital markets to raise a LOT of money) and even other banks. For some non-bank lenders, it can even be a fund that your average mom and dad investors can invest in.

This is covered in a little more detail right here – Ever wondered how your mortgage is funded?

Don’t the banks use the cash rate to work out the interest they have to pay back?

Short answer? No.  No, the cash rate is NOT the rate that is used to determine the interest rate on home loans.  Even the RBA states that the cash rate is simply a rate that helps to determine the “market reference rates” that can be used to determine the cost of funds – you can read up more about what influences bank funding costs here on the RBA site.

Essentially – the Official Cash Rate is a target set by the RBA.  Bank Bill Swap Rate (BBSW) is a commonly used market reference rate for obtaining wholesale funds that can be influenced by the Cash Rate (or not) and one that should be looked at as well.  Just because the Cash Rate decreases, it doesn’t mean the BBSW will.  While it often does, the BBSW is determined by market forces, not the RBA. If the difference between the Cash Rate and the BBSW becomes wider, then the cost of funds becomes more expensive and existing customers may not see any benefit to a reduced cash rate.

As much as the media would like us to believe that the banks’ lending rates to us come straight from the cash rate, it’s simply not correct.

Why do new customers get better rates?

Now that we know the concept that everyone is borrowing from somewhere, it’s important to understand the above concept that your borrowings are locked in at a rate that the bank needs to repay.  This is especially true in the wholesale markets (where Well Money gets its funding from).  Over time, the wholesale markets get access to newer funds at a different market reference rate.

Sometimes this can be higher or lower than what your home loan was funded at – the new cost of funds has nothing to do with existing customers.  As an existing customer, the funder still needs to pay back the money that they borrowed in the first place along with the agreed-upon interest at that time.  Even as the RBA states “the interest rates banks pay for different sources of funding don’t necessarily move by the same amount or at the same speed as a change in the cash rate.”

So a new source of money is found.  If this is cheaper than previous sources (ie where your loan got funded from), it means that there’s a decision to make.  Pass it on to new loans or don’t pass it on.

Am I getting ripped off?

This is a hard one to quantify.  Given what we’ve learnt, if a lender is keeping the rates for new customers the same as existing customers and a cheaper source of funds is being obtained – how much of that is being kept to themselves?

If a lender has a new rate for new customers – it isn’t a loyalty tax, it’s just a by-product of how the cost of funds work.  There will come a time when it’s no longer possible for a lender to drop an existing customers rate – they could end up losing money by having you as a customer!

Will Well always pass on rate drops?

Unfortunately, no.  But we will always look to make sure you’ve got a competitive rate.

As we’ve discussed above, when we have a new rate made available to us, it means we’ve been able to lock in a lower price with our funder. It doesn’t change the rate that we were able to secure for our existing customers – that money has been lent to you already.

So, for new loans – we choose to pass it on.  By doing so, it means we’re not profiting from new customers by saying that everyone’s rates will be the same, because as we’ve seen above – the costs aren’t the same.  And it also means that we’ve consistently been able to offer some of the lowest rates around.

A final thought – Will we always pass on rate increases?

While we’re in the current economic climate, it’s easy to talk about saving money.  But what will happen when interest rates start to rise (hopefully not for a long time)?  Well, the same philosophy will apply.  We will choose to pass it on to new customers.

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