Know of a story where someone gets a better deal as a new customer, in comparison with a current one?
In the finance world, we call this back book versus front book pricing. Where new customers (front) are offered better terms, generally represented in terms of an interest rate, than a current customer.
Why is It?
Banks have been under significant competitive pressure on pricing, even despite the wave of growth in lending and property values.
This has intensified with a number of strategies, including "cash back" offers as an incentive for new mortgage customers to switch lenders.
Of course, profit margins will decrease further if credit providers offer existing customers as good a deal on their interest rates, in fact collectively it is in the billions of dollars.
Relevance in Changing Interest Rate Environments
Interest rate divergence generally becomes a political one whenever rates move up or down, such as when the full amount of official cash rate reductions were not being passed on during Covid-19.
Both Government, and through it outlets such as the ACCC have brought pressure for unity on back and front book pricing.
The data is not totally conclusive though most estimates show that the gap between from and back book is around 40-60 basis points (0.40% - 0.60%). When the data is broken down, anecdotal evidence largely, some lenders show even bigger gaps.
As a general rule, the older the loan the greater this spread is likely to be. Part of the challenge is applying the new rules to older loans.
Bank Responses
Despite this being a PR battle banks are never going to win, we have seen tangible evidence of banks re-pricing existing customers, and making it easier for this to happen.
Mortgages in particular are being turned over more quickly, so banks need to be more nimble in connecting to their customers.
However, in the current tightening environment we are already seeing instances of back and front book gaps, with some banks passing on the full amount of the official cash rate to the back book, whilst offering rate incentives for new customers.
Apples & Oranges
As a pausing point, borrowers should be aware that it is increasingly difficult to compare different types of customers and/or loans.
The finance market is becoming a lot smarter, and it always puzzled this writer historically why mortgages in particular haven't been more "priced to risk". Yes, we had the post GFC caps on investor and interest only lending, though there are extra complexities at play now.
For example, your interest rate can be now be materially impacted by:
- The Loan to Valuation Ratio ("LVR")
- Your Credit Score
- Your Debt to Income Ratio ("DTI")
These factors draw on some fundamental principles of lending, though are relatively new in driving interest rates, so you may need to read the fine print when comparing different finance offers.
Balancing the Books
A newer innovation from some lenders is a "guarantee" of parity between customer rates on existing and new loans.
This is a sound principle, providing ongoing certainty to customers. A potential limitation is the cost of keeping the back book priced competitively. This may ultimately limit the capacity for the credit provider to provide the lowest rates to new customers.
Though initiatives like these are a step in building stronger customer connection; and in turn, help close the gap between front and back book pricing on a sustained basis.
More Information?
Contact MCP:
P- (03) 9620 2001 or your Finance Partner
E - enquiry@mcpgroup.com.au
The team at MCP Financial Services has specialised expertise in all Mortgages. We can assist with home and investment loans, review and restructuring, refinancing and renegotiating.