I was staggered recently to read an article by a professional finance journalist, in a daily publication, stating that borrowers should refinance their loans to those financial institutions with the lowest interest rates.
For obvious reasons I won’t name the journalist or their publication, but what concerned me the most is the article did not consider any loan costs outside of the interest rate. This is despite the significant effort made by governments, mortgage industry associations, mortgage brokers and even lenders in providing consumers with more and more details on total loan costs over recent years.
That is like saying I should buy a $45 dollar shirt with postage & handling of $10 online as it is cheaper than paying $50 in the local store. Sure the purchase price is cheaper online, but the total cost to purchase the shirt is greater!
To make my point further let’s consider two loan options for a $250,000 loan repaid monthly over 25 years, both with variable interest rates and no application fees. For the point of the exercise we will assume all other valuation and documentation costs were the same and interest rates remain stable.
Option 1: The first has a low interest rate of 4.59% per annum and an annual fee of $500.
Option 2: The second has a higher interest rate of 4.75% per annum, and no ongoing fees.
At first review Option 1 looks a lot more attractive. Those amongst us with a good grip on the numbers would be able to complete some simple calculations and note at the end of the first year both loans have cost a similar amount in terms of interest cost and fees.
But what about over the full term of the loan?
The below table provides an indicative summary of total costs over 25 years assuming only minimum repayments are made and interest rates remain stable:
|Option 1||Option 2|
|Total Interest Paid (approx)||$170,714.92||$177,588.02|
|Total Annual Fees||$ 12,500.00||$0.00|
|Total Interest & Annual Fees||$183,214.92||$177,588.02|
In this example the cheaper interest rate of Option 1 has actually cost us $5,629.90 more over the term of the loan. Many would argue that the difference over the full term of the loan is not significant but I wonder whether in real life the annual fee may be subject to some increases over the next 5, 10 or 20 years?
When assessing interest rates we also need to consider many other options before considering what is a good deal, such as:
- What are the service levels and policies of the two lenders? Will one be more difficult to deal with than the other?
- What has been the historical performance in interest rates for both lenders? Is the cheaper option just a short term discount?
- What are the other costs and fees I may incur over the terms of the contract?
- If I am refinancing, what are the costs to exit my existing contract?
- If I want to transact at the same institution my loan is at, what are their transactions fees? How convenient is access and is it important to have a branch nearby? What is their internet banking like?
- What are the other features of the loan? Can I redraw additional payments or have a loan set off account at no additional cost?
- Am I comfortable dealing with that lender? Would I prefer to deal with a lender who does more in my local community?
Depending on your personal circumstances you may have other important factors that need considering.
So should you try to get the lowest interest rate you can? Most definitely! But keep it in context that interest is only one cost of your loan and you need to consider all fees and costs, along with other aspects important to you before making a decision.
The lowest interest rate loan isn’t necessarily the lowest cost option!
However, assessing all aspects can be confusing. This is where consulting your local Loan / Mortgage Broker or Credit Adviser can provide assistance in working through the options on offer and help you establish what will suit your personal circumstances.