Landmark in ‘basic variable’ loans - Newsletter 2005

Competition has driven lending margins down to a new low – and it makes a difference to your lending. All investors should consider taking advantage of a new generation of low cost loans for investors and home owners alike.

Ever since mortgage securitisers undercut them in the mid 1990s banks have responded with multiple tier marketing and product differentiation. The traditional ‘standard variable rate’ remains today at 7.32% but ‘basic variable rate’ loans with an additional discount of 0.5% or more and low fees have been available for years.

Banks cut their margins to compete. But they didn’t do it by cutting their standard interest rates, as this would cannibalise both their higher margin sales in the future, and also their entire stock of outstanding loans.

Instead they invented new products and ‘special’ discounts, all the while trying to restrict the impact on their precious margins. Even though banks removed features like the option to make capital repayment and redraws on their cheapest loans, competitive pressures have been forcing them to lower rates and improve features ever since.

Until recently, features typically absent on ‘basic variable’ loans included:

• Offset accounts

• Redraws without fees

• Interest only options

• Sub-accounts on the one loan.

Offset accounts are handy for homeowners, increasing the efficiency of their loan as your loan balance is optimised, your interest being offset for every cent in your offset account for every day it’s there.

The last two features are often advisable for investors, even indispensable,. Interest only is usually preferred to prevent repayment of capital, thus maximising gearing. And sub-accounts allow the borrower to separate borrowings for investment from personal purposes (like your credit card expenditure and/or loans to purchase your residence) as interest on investment lending is generally tax deductible.

The banks’ problem was that securitisers weren’t forgetting the investor market either so the banks came up with the ‘professional package’. Often packed with better features than their ‘standard variable rate’ loans, professional packages had most or all of the features outlined above, and a discount against the standard variable rate of 0.5% or more.

Again, trying to contain cannibalisation of higher margin products, professional packages were initially offered only to those in specific professions and then to those over a certain income. But as with the restrictions on basic variable rate loans, these restrictions have gradually succumbed to competition.

As the attached graph from the Reserve Bank shows, housing loans with interest rates even close to the standard variable rate of 7.32% are now very much in the minority.

Standard variable rates exist today mainly for marketing purposes. It’s much more appealing when a salesperson tells you your loan is 0.5 percent below the standard variable rate rather than telling you it’s 0.2 percent higher than the better basic variable rates!

Yet fees have often remained with professional packages. One popular model has an annual fee of around $300, replacing application and monthly fees and entitling you to a range of add on services – such as a free credit card.

Now the good news! For the first time, basic variable loans are available that provide all the essential features for most investors without monthly or annual fees. They are not quite as fancy as some professional packages but still permit most essential structures that investors need – and they can often purchase add-ons like offsets for less than the charges they’d bear on a professional package.

What’s more, they’re available with discounts against ‘standard’ variable rates of 0.7 percent, or even more. They also provide a good basis on which to approach other lenders to negotiate a better rate on professional packages and other special deals. So if you’re on a standard professional package, give us a ring and we’ll see if we can help.

Remember the beauty of compound interest means that acting now makes a huge difference. Saving just 0.1 percent and the $300 annual fee on a professional package of $400,000 with a 30 year term can save you nearly $60,000 over thirty years!

And remember, if you’re worried about break costs, or application fees, our rebate of $1,000 or more usually takes care of that with plenty left to spare. Ring us on 1300 13 75 86 or e-mail me Nicholas and I’ll take you through the maths. And if you don’t fancy the hassle of filling out another application form, I'll get someone to visit you to do it for you!

Give us a ring!

Ring me 1300 13 75 86 and I’ll be happy to talk you through any of the points I’ve made in this newsletter.

October 2005

The observations made here are general and indicative. They are not warranted as free from error in any respect whatsoever. We are not financial or tax advisers and you should not rely on any aspect of these comments without taking independent financial advice relating to your own specific circumstances. We suggest you obtain advice on a fee for service basis rather than from someone who earns commissions from investments they recommend.

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