Mortgagors move to pay down debt

Three months ago, the Reserve Bank of Australia (RBA) cut the official cash rate for the first time in almost three years, bringing the interest rate to a new record low of 1.25 per cent.

This was quickly followed by a second rate cut in July, when the cash rate moved even further – to 1.00 per cent.

By comparing AMP Bank customer movements six weeks prior to the first rate cut, to those made six weeks after, the lender revealed that there had been a 14 per cent increase in the number of home loan customers switching from IO to P&I repayments ahead of their five-year expiry date.

With many lenders passing on partial or full rate cuts to home loan customers, the data suggests that a greater number of mortgagors are taking advantage of record-low interest rates and making the decision to pay down their debt faster.

CEO of AMP Bank Sally Bruce commented on the findings: “The recent rate cuts have put more money in the pockets of home owners, and we are seeing a significant uptick in the number of those customers opting to pay down their debt with the extra funds that they have.

“Whilst interest rates are at record lows, there is no better time to pay down debt to own your home or investment property sooner. Home owners are sometimes unaware of how powerful extra repayments can be – those who are able to increase their repayments now will pay less interest over the life of their loans.”

According to the Reserve Bank of Australia’s lending rates data for June, IO home loan rates are, on average, 50 basis points higher than P&I rates for owner-occupiers.

AMP Bank suggested that a home owner with an average 30-year $400,000 home loan (first five years interest-only and remaining 25 years principal and interest) switch to paying P&I two years earlier, it would initially cost an extra $517 per month. However, they would save $14,711 over the life of their loan as a result of starting to pay down their debt earlier.

“Switching to principal and interest will cost home owners more in the short term, but over time the customer could save thousands of dollars in interest as a result of paying off their debt sooner,” Ms Bruce said.

“These decisions always come down to a customer’s personal circumstances and capacity in their budget, but if their situation allows it, the short-term pain may be worth the long-term gain.”

Further rate cuts expected

The data comes after the decision was made by the RBA this month to hold the official cash rate at 1 per cent.

However, many in the industry expect more rate cuts to come before the end of the year, with some expecting a cut of 25 basis points as early as October.

While it is uncertain whether lenders will pass on the full rate cut to customers, a further cut by the RBA will undoubtedly see home loan interest rates become “a little bit cheaper”, according to founder and CEO of Empower Wealth Ben Kingsley, as lenders will be expected to reduce their rates further.