A guide to refinancing your home loan
With the home loan market constantly changing, there is a chance that you may no longer have the most suitable home loan.
Regularly reviewing your home loan and seeing what other products are available is a great way to save more money and even pay off your home loan sooner.
How refinancing works
Refinancing, sometimes referred to as switching, is when you change home loans to an option that better suits your needs. This is often done to secure a more competitive rate, better features or superior customer service. Refinancing allows you to change lenders part way through the loan term and could potentially save you thousands of dollars in interest over the life of the loan.
Refinancing pros & cons
Find a lower interest rate: This is a prime reason for refinancing. A lower interest rate could save you a substantial sum over the life of the loan and help you pay off your home loan quicker.
Find a loan with better features: When you first took out your home loan, things like an offset account, interest only repayments and free redraw may not have been a priority. Over time your priorities change and getting a loan with more features could actually help you save money and pay off your home loan faster.
Find a better lender: If you are not happy with the service you have received with your current lender, you don’t need to stay with them. Without early exit fees you are free to find a lender who provides superior customer service.
Consolidate debt: If you having trouble paying off smaller debts with high interest rates, you can increase your home loan – which will typically have a far lower interst rate – and use the money to pay these off. This could give you some valuable breathing space and a single repayment, allowing you to focus on paying it off as quickly as possible.
Access equity: Some borrowers refinance so they can access the equity that has been built up in their home. The additional funds can be used for things such as renovations, a holiday or a new car. The interest rate that is paid can be a lot lower than a personal loan or car loan.
Invest elsewhere: Once you are getting close to paying off your home loan, you may wish to borrow funds to invest in another property or shares or managed funds. This could be a cheaper option than most margin loans and come with a lot less restrictions like margin calls.
Cost of refinancing: Unfortunately, the cost of refinancing to another loan or lender may can add up. There are can be fees to both discharge your current loan and setup your new loan, and if you don’t do your calculations or refinance too often, you may end up spending more in fees than you would have saved in interest by chasing a lower rate.
Increased loan term: When refinancing, you can choose a different loan term. If it is longer than what is remaining on your current loan, then even though the interest rate may be lower, you could end up paying more over the life of the loan. To avoid this, resist the temptation to increase the loan term, even if repayments are a lot lower.
Consolidated debt costs you more: If you have increased your loan to payoff other debts, you need to focus on paying this off quickly and not just revert to making minimum repayments on the new loan amount. If you do, you could end up paying a lot more in interest and spread this debt over 20 years or whatever the loan term you choose.
Damage to your credit history: Any credit enquiries are recorded on your credit report, so applying with more than one lender. can result in a large number of enquiries, which can damage your credit score.
Lose equity due to poorly performing investments: Borrowing against your home loan to invest can be a cost-effective strategy but if your investments perform poorly, the interest you pay could outweigh the income and capital gain from the investment. Worst case, if the investment turns sour, you could be left with a loan after the investments are sold.
Only submit a formal application with the lender you intend to go with. Multiple credit enquiries can have a big impact on your credit report.
Your property’s value
When refinancing your home loan, your property’s current worth will determine how much you are able to borrow, and even whether you can refinance or not.
The more equity you have, the better. If you are able to borrow 80% or less of the property’s value not only will you avoid Lender’s Mortgage Insurance, but you may also receive a more competitive interest rate.
Most lenders will only refinance loans up to 90% of the value of the property. Even then, mortgage insurance will be charged and could add thousands to your up-front costs. If you borrowed a high proportion of the purchase price and property values haven’t increased, you may find that you are unable to refinance or the cost of having to pay mortgage insurance again may outweigh the benefit of a lower rate.
The lender will have a valuer complete a valuation of the property to determine its value. To research the value yourself upfront you can:
- Research recent sales of similar properties in your area. It is the amount that a property actually sells for that is relevant, not a list price for a property currently on the market. In your research, collate a list of properties that have sold. particularly focusing on what has sold within the last six months.
- Compare like for like. When you are looking at sales of similar homes to your own, ensure that they are comparable. The sort of things to look for is properties with a similar land area, type of construction, number of bedrooms and additional features. If the homes you are looking at are better or worse than yours, you will need to adjust the value accordingly. A real estate agent may be able to assist with quantifying how much these features or improvements would impact on value.
- Get reports that include sales data. There are a large number of reports available online that will provide estimates of what your property is worth along with recent sales to back up the estimate. Real estate agents also have access to data on recent sales.
WHAT IS EQUITY?
Equity is simply the difference between what you owe on the home loan and what the property is worth. For example, if you have a property that is worth $400,000 and you owe $250,000, your equity is $150,000. Your equity increases as the value of the property increases over time and as you pay down your home loan.
Although refinancing your home loan could potentially save you a lot of money, there are some costs involved. These fees may include:
- Break costs: For those within the fixed period of a fixed rate home loan, you may be charged a 'break cost' if you refinance.
- Discharge fees: This fee is charged by most lenders when the loan is closed. These will be outlined in the loan contract.
- Loan setup fees: When you refinance, the new loan may have upfront setup costs that you will be required to pay. The most common fees include loan application fee, valuation fee, title insurance and/or a settlement fee.
- Lender's Mortgage Insurance: If you refinance and your loan is still above 80% of the value of the property, your new lender will still charge LMI. This is probably the biggest reason why people choose not to refinance, as the cost can add to thousands and can negate the benefit of refinancing to a lower interest rate.
- Government fees: State Governments charge a mortgage registration fee when you refinance. It is charged twice, once to remove the old lender and once to register the new.
To calculate whether it is financially worth refinancing, calculate the interest saving per year on the lower rate and put a value on savings that come with any additional features. Add up the refinance fees above and any additional ongoing fees. Compare the two figures to determine how many years it will take to benefit from refinancing.
Top tips for refinancing
- Don’t refinance dollar for dollar. If you apply to refinance exactly what you currently owe, you may be left to fund a shortfall at settlement. The payout figure on your old loan could be higher than what you currently owe due to the discharge fees and interest that has accrued on the old loan that hasn’t been paid yet.
- Keep the same remaining term. When refinancing your current loan, pay particular attention to the new loan term. If you don’t pay attention, you may be signing up for the maximum loan term. Although the repayments may be less, you will end up taking a lot longer to be mortgage-free.
- Loan setup fees. When you refinance, the new loan may have upfront setup costs that you will be required to pay. The most common fees include loan application fee, valuation fee, title insurance and/or a settlement fee.
- Don’t make minimum repayments if you have consolidated debt. Paying out high interest debts can be a relief, but if you don’t focus on paying the extra amount off, you will be spreading this cost over the term of your home loan. Instead, ask your lender to tell you how much extra you need to pay extra to pay the additional amount off over a few years.
- Don’t refinance too often. Refinancing can be a vicious cycle of chasing the cheapest interest rate. Each time you refinance, you are incurring costs and getting enquiries on your credit report. Refinancing should only be undertaken after careful consideration.
- Consider the buffer you need. If you have paid extra and have redraw available, you will need to consider if you want to maintain this or not. If this is your emergency fund, then you still may want to have access to it. To do this, you will need to ensure that the loan amount doesn’t include the redraw.
- Choose conservative investments. Borrowing to invest comes with risks. It may be wise to get financial advice and invest conservatively so that you don’t end up with a loan remaining after the investments are sold.
- Get financial advice. If the loan is for an investment property, it may pay to consult your accountant to ensure that the amount you refinance for and the features of the loan don’t jeopardise the tax deductibility of the loan.
- Be realistic about the value of your property. Just because a neighbour’s property sold for a certain amount a few years ago doesn’t automatically mean that this will be what your home is worth. Do your research before you apply so you don’t end up paying the cost of the valuation only to find that the value comes in a lot lower.
- Crunch the numbers before applying. With all the changes to lending policies, you may no longer be eligible to borrow the amount you qualified for in the past. To avoid disappointment, get all the calculations done upfront before you apply.
Borrowers can forget that the interest charged on their loan is in arrears, which means that interest is calculated daily but only charged to the loan at the end of the month. If you don’t want to use your savings to fund the shortfall, always choose a higher loan amount to ensure there is sufficient funds. Your lender should be able to help with the calculation.
A home loan that can be split into portions can be handy for separating the amount you owe on your home from debt that you have consolidated. By having it in a separate account, you can focus on paying it off quickly.
Applying the do's and don’ts
Shop around. Lenders are regularly changing their home loans and introducing new products, so it’s worth keeping up to date with what is available.
Do not send in multiple applications. If you are interested in a home loan, make sure that you have fully researched it first and only apply after you are certain that you will qualify. If you have multiple home loan application enquiries on your report, it may give other lender the impression that you have been declined, which may affect your chances of getting a home loan.
Don’t apply for more credit. If you are interested in a home loan, make sure that you have fully researched it first and only apply after you are certain that you will qualify. If you have multiple home loan application enquiries on your report, it may give other lender the impression that you have been declined, which may affect your chances of getting a home loan.
Don’t change jobs. Lenders need to ensure that you can meet the loan repayments and will be looking carefully at your income. The important thing is stability, so if you have changed jobs recently, they will look at how long it took you to find a new job and whether you are in a similar role in the same industry. You may be required to have started your new job or have been in it for a while (or even passed probation) before the lender will be comfortable using your income.
Get your paperwork ready. You can reduce the waiting time and speed up the process by providing your lender with all of the required supporting documents in one go. Start holding onto your payslips, payment summaries, mortgage statements and the like, as these will probably be needed.
Find the right lender. Finding a lender that understands what you are looking for and will take the time to explain the benefits can be a big help. If you are speaking to the lender direct, use all your conversations with them to determine if they are the right lender for you. Alternatively, you can check reviews online to see how existing borrowers rate their service.
The opinions expressed in this article are the opinions of the author(s) and not necessarily those of homeloans.com.au. The above is general commentary only and is not advice tailored to any individual's financial situation. We recommend seeking advice from a finance professional before implementing changes relating to your finances.