Low interest rates vs cashback offers: Which is better?

Low interest rates vs cashback offers: Which is better?
If you’re in the market for a new home loan, loans.com.au discusses the differences between low interest rates and cashback offers.
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With loan cashbacks on the rise in line with the booming Australian property market, you might be unsure whether to search for a lower interest rate or a cashback offer.

While most cashback offers are for people that are refinancing a mortgage, though there are some available to first-home buyers, there are things you should know before deciding which home loan option is right for you.

What exactly are the differences between low interest rates and cashback offers on home loans? And which is better?

Low interest rates

Finding a home loan with a low interest rate can be a great option for many home buyers. Typically, lower interest charges equal lower repayment amounts, which can make a mortgage more affordable.

Interest charges are a major factor in the overall cost of a loan, though it is not the only influence.

There are a few factors that affect low interest rates, both short-term and long-term, including wage growth, inflationary pressures, et cetera. However, one main factor affecting the recent low interest rates is the Reserve Bank of Australia (RBA) cash rate, which is currently at a record low of 0.1%.

A home loan interest rate of 4% was once considered ‘low’, whereas currently, there are some lenders that are offering mortgage interest rates below 2%.

Cashback offers

A cashback home loan offers a lump sum of cash, often thought of as ‘free cash’, that is deposited into your bank account once the loan settles. While cashback offers can seem like a great deal, it’s important to consider other factors of the loan before deciding it’s worth it.

There are currently many lenders offering cashback deals, ranging roughly from $1,000 to $4,000, to try and compete with low interest rates being offered.

Many of these lenders only offer cashbacks to people that are refinancing, though some offer for both new loans and refinanced loans. There are also a few lenders that offer first home buyer cashback deals.

Cashback offers can be enticing as it can seem like you’re receiving ‘free cash’. However, it’s important to note that in many instances, interest rates are higher on loans with cashbacks, which can end up costing more in the long-term.

In addition, there are usually a few criteria that might need to be met to be eligible for a cashback offer, which can include:

  • A minimum loan amount
  • Time constraints, e.g. the loan must settle by a certain date
  • The loan purpose
  • Having an account with the lender

Quick case study

Let’s look at a hypothetical example to compare these two options. Using the two options discussed, a low interest rate and a cashback offer, it might become easier to see the differences. In this example, the principal amount borrowed will be $500,000 over a 20-year loan term.

For the low interest rate option, let’s use a variable rate of 2% p.a., with monthly repayments. Using a mortgage calculator, the total interest payable over 20 years with this interest rate would be $107,060.

For the cashback offer, let’s say you get $3,000 cash back, and a variable interest rate of 2.5% p.a. Following the same terms, using a mortgage calculator, the total interest payable over 20 years would be $135,883.47. This, minus the $3,000 cashback, would mean you need to pay a total of $132,883.47 in interest charges.

In this instance, the low interest rate example would be the better option. This is because even with the cashback offer, you would end up paying an additional $25,823.47 in interest.

Things to consider before making the switch

If you’re considering refinancing, and you’re not sure whether to look for a low interest rate or a cashback offer, here are some things you might wish to consider. Alternatively, you could compare these two options by using the following questions as a basis.

  1. If it’s a cashback offer, will you need to open a savings or transactional account with the lender? If so, are there any fees involved in account upkeep?

  2. What is the new lender’s settlement fee and other costs of refinancing?

  3. What is the comparison rate of the new loan? This rate will include interest and any other applicable fees and charges - this can give you a realistic idea of how much you actually pay over the loan term.

  4. How much are the solicitor fees and taxes going to cost you?

  5. How does the new rate compare with other rates that are currently available?

  6. Are you trying to quit a fixed rate? If so, this can incur additional fees, which could be thousands of dollars.

  7. If the new mortgage has a fixed rate, does it roll into a higher variable rate after the fixed rate period ends?

Ultimately, it is up to you which option you choose, and there is no shortage of either. Comparison sites are great tools to research all of the offers available at the time of your search, and can help give you a clear idea of what options are out there.

For example, if you’re looking for a low interest rate home loan, loans.com.au offers a 1.85% interest rate p.a. on their Smart Booster Home Loan. Find out if you qualify for a home loan today!

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Frequently asked questions

How do cashback offers work?

A cashback offer means that the lender will offer you a lump sum of cash. This may be offered via direct deposit, subtracted from your loan balance or application fees, or provided as a gift card. Cashback offers are typically used as an incentive by lenders to attract new customers/entice customers to switch to their offered home loan.

Do you pay tax on a cashback?

According to the Australian Taxation Office (ATO), the cash doesn’t need to be reported as income as it relates to a borrowing rather than an investment. Meaning, you won’t need to pay tax on the cashback received.

What is a variable interest rate?

A variable interest rate is a type of interest rate that fluctuates over time, as it is based on an underlying benchmark that changes periodically. A fixed interest rate, which is the other common form of interest, remains the same throughout the defined period.

Tags: mortgage refinance | refinance your home loan

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