Should you lower your home loan repayments?

Photo by Maximillian Conacher on Unsplash.

Home loan interest rates are at record lows these days. But that doesn’t necessarily mean your mortgage repayments should be lower too.

• How much have rates decreased by?
• How can you lower your repayments?
• Lowering your repayments: the case for
• Lowering your repayments: the case against
• How else can you save on your home loan?

A lower cash rate usually means lower home loan rates, and lower home loan rates mean lower minimum home loan repayments. The voice in your head might tell you “hey, it’s me, the voice in your head, make sure you lower your home loan repayments so you can get some extra money to spend each month,” and there are definitely merits in doing so. But there are also merits to continuing to pay off your home loan without dropping your repayments to the lower minimum.

Let’s find out why.

Looking for a low variable rate home loan? The table below displays a selection of variable-rate home loans on offer, featuring a low-rate pick from each of the following three categories: the big four banks, the top 10 customer-owned banks, and the larger non-banks.

How much have rates decreased by?

Home loan interest rates have been in free fall since the Reserve Bank of Australia (RBA) resumed its policy of cutting the cash rate. In 2019 there were three 25 basis point (0.25%) rate cuts - in June, July and October - taking it down to 0.75%. Before these cuts, the cash rate had been on hold at 1.50% for nearly three years, with the previous cut taking place in August 2016.

Over 2019, many variable home loan interest rates were cut by less than what the RBA cut the cash rate by. The big four, for example, cut variable home loan rates by an average of 57 basis points - 18 basis points less than the RBA’s 75 basis points - drawing the ire of the Treasurer. However, there were some lenders that passed on the full cut to variable home loans in each of the three months.

But it was a different story when it came to fixed-rate home loans. In some cases, fixed-rate home loans were cut by more than the RBA’s cuts. Westpac and its related brands, for example, cut various fixed-rate home loans by up to 130 basis points. Fixed rates are now well below 3% p.a. in many cases, although this may be intentional by lenders who want to lock people into a certain rate before future rate cuts occur.

How can you lower your repayments?

Contrary to what some may believe, your home loan repayments don’t always automatically reduce in line with a reduction in your home loan’s interest rate. This usually happens on a case-by-case basis. For example:

• Bankwest (owned by Commbank) “automatically passes on the interest savings to the customers from the effective date of the interest rate change”

• But Commbank itself “proactively notifies customers if they are eligible to reduce their minimum repayment amounts” and it’s up to that customer themselves to contact the bank online, via phone or branch to inform them they would like to reduce their monthly repayments

Another example is NAB, which requires its customers to notify if they want their repayments reduced while its subsidiary UBank automatically reduces customers' repayments.

Each of the big four requires the customer themselves to take the first step, according to responses given by bank representatives to the House of Representatives Standing Committee on Economics in November 2019.

Based on the representative’s responses, less than 10% of big four mortgage customers had actually requested an interest rate reduction:

• 7.0% of ANZ’s 680,000 variable P&I customers (47,600)

• 6.9% of Commbank’s one million variable P&I customers (69,000)

• 0.9% of Westpac’s 1.1 million variable P&I customers (99,000)

• 0.7% of NAB’s variable P&I customers

So don’t automatically assume your repayment has been lowered if that’s what you want - you might still need to contact your bank to see if they’ve already lowered your repayment or if you need to ask them.

Lowering your repayments: the case for

The biggest reason why you’d want to lower repayments is if you’re struggling to meet them. Analysis by Digital Finance Analytics (DFA) in November 2019 estimated 32.2% of all households (that’s more than one million) are currently suffering “mortgage stress” - an affliction whereby 30% or more of household income is spent on mortgage repayments. What’s more, about 1% of mortgages are said to be in 90+ day arrears, where borrowers are behind on their payments by 90 days or more, putting them at serious risk of default. In such instances, home loan repayment reductions could be a welcome reprieve.

Let’s see how much you could save each month on a $400,000, 30-year home loan with P&I (principal and interest) repayments if, two years into the loan, your interest rate is cut from 4.00% p.a. to 3.50% p.a. and you let your minimum home loan repayments fall accordingly.

Note: This scenario assumes there’s no more rate changes after the rate falls to 3.50%

By dropping your repayments from $1,910 to $1,802 you would have an extra $108 each month - money you could put towards utility bills, groceries or stuff for your family.

Assuming no more rate changes (which is unlikely, but makes it easier to demonstrate), your total repayment over the life of the loan would be $651,312, which means the rate cut saved you $36,166.

You don’t even necessarily have to drop your repayments because you have to - you can do it because you want to, if, for example, you want to free up some money for various expenses. Short-term this can be beneficial, but as we’ll explain below, it may not be as beneficial long-term.

Lowering your repayments: the case against

Unless you’re struggling to meet your repayments each month/fortnight/week, it can actually be beneficial to not lower your repayments and instead continue on as you were before your interest rate was cut.

Why, you ask?

Because the amount you can lower your repayments to after a rate cut is the new minimum repayment required. You can pay more than the minimum repayment and actually pay off your home loan faster, since a greater share of your repayments will be paying off the loan’s principal and less in interest.

So if you don’t need to lower your home loan repayments, you don’t have to. You can pay off bigger chunks of your home loan by keeping repayments the same, as this could be much more financially beneficial than saving money to spend on items in the short term, as home loans are one of, if not the single biggest expense you’ll ever have.

Using the example above, you can see the tens of thousands you could save by resisting the temptation to lower your repayments after a rate cut from 4.00% p.a. to 3.50% p.a.

Note: This scenario assumes there’s no more rate changes after the rate falls to 3.50%

Assuming you kept your repayments in this mock scenario at $1,910 despite the lower interest rate of 3.50% (which kicked in two years into the loan), the rate cut could save you $58,670 over the life of the loan - over $22,500 more than if you’d lowered your repayments to the new minimum of $1,802.

It could also see you could pay off your loan two and a half years earlier!

How else can you save on your home loan?

There are a few other ways you can save money over the course of your home loan besides keeping your repayments the same or switching to a lower interest rate.

Use an offset account

An offset account is an account linked to your home loan, and the money in this account is “offset” against the balance of your loan, meaning you only pay interest on the difference.

With a 100% offset account, if you had a loan of $400,000 and had $40,000 in an offset account, then you would only have to pay interest on $360,000. The more you have in an offset account, the more you can save in interest, which, in turn, can shorten the life of your loan. Just bear in mind that offset accounts can often cause home loans to have slightly higher interest rates but not always.

Read our article on offset accounts for more detailed information on how they work, and also consider reading up on how they compare to redraw facilities.

Pay more regularly

Making more frequent repayments, such as paying fortnightly or weekly instead of monthly, can trick yourself into making an extra month’s worth of repayments each year - saving you heaps in interest. You can do this by contacting your lender and adjusting your repayment schedule, but make sure the fortnightly repayment is exactly half the monthly repayment (or a quarter if repaying weekly), otherwise you won’t save as much. Read our article on this for a demonstration of how this works.

What to do if you’re struggling to meet your repayments

If you’re struggling to meet your repayments, then lowering them to the minimum can be a viable option. If you’re still struggling, you need to look for alternative solutions unless you want to potentially lose your home and ruin your credit history.

Consider trying any of the following solutions:

• Ask your lender for a repayment freeze: contacting the lender should be your first call of action, and they may be willing to freeze your repayments till you get back on track (also known as a repayment holiday).

• Contact your lender’s hardship team: most lenders should have a financial hardship assistance team, which can help you work out solutions. It’s in their interest to do so as a paying customer is more valuable to them than a home they need to repossess and then sell.

• See what else is out there: if possible, refinance to a different home loan with an even lower interest rate, and do it before you start missing repayments. Otherwise switching could be harder as lenders might view you as a riskier customer.

• Consider accessing your super: in extremely limited circumstances, you might be allowed to access your built-up superannuation, but this should only be done as a last resort to save your home. You’d need to contact the ATO (Australian Taxation Office) to apply.

Also check out our ultimate guide to budgeting and saving to see what else you can do to stop splashing so much cash.

Savings.com.au’s two cents

Falling interest rates are almost exclusively a good thing for homeowners and investors, as they represent a chance to either lower your repayments or pay off a mortgage faster. You can contact your bank to ask them to lower your repayments if they haven’t already, but hopefully this article has made you reconsider if you need to do so.

In addition to saving interest and paying off the loan quicker, not lowering your repayments can also help you avoid repayment shock should interest rates ever increase again. Australia currently has record low mortgage rates but they probably won’t stay this way forever. You might feel comfortable making low repayments now, but could you afford larger repayments in future if a lender increases your variable rate? Just something to consider.

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Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

• The big four banks are: ANZ, CBA, NAB and Westpac
• The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
• The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.

Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.

In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.

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