Doing so can help you to either generate savings or leverage your wealth growth. But like many things in the money world, refinancing can sting you if you’re not careful, so there are a few things you should consider before refinancing your home loan.
What to consider before refinancing a home loan:
1. Why refinance?
Take the time to properly consider exactly why you want to refinance your home loan.
Ask yourself:
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Are you after a cheaper rate?
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Do you want more flexibility in the loan (e.g. with an offset account or redraw facility)?
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Are you consolidating debt?
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Do you need to access the equity to pay for something major such as a renovation?
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Do you want to increase or shorten your loan term?
Having a clear understanding of what you hope to achieve by refinancing can help you make a better decision.
2. Costs to refinance a mortgage
The numerous costs of refinancing a home loan can sometimes set you back thousands, leaving you wondering whether it was worth it.
To avoid any nasty surprises, look at the terms and conditions of both your existing home loan and the loan you’re looking to refinance with to discover what the ‘change’ costs will be, including discharge fees, valuation fees, break costs, etc.
If you’re refinancing to get a lower interest rate, you should first calculate how much less you’ll pay in interest at that rate (you can do this using our home loan repayments calculator) and compare this saving to the total cost of refinancing. That should give you an idea of whether the refinance is worth it.
You may find that through the interest savings, you’ll make back the refinancing costs within a year. If it’s going to take a several years to recoup the cost of switching, you may need to consider other options.
3. Property value & your equity
Whether you’re refinancing to secure a lower interest rate or to free up some cash from your home loan, you need to consider the current value of your property and how much equity you have in it.
You can use loan-to-value ratio (LVR) as a measure of equity. This is expressed as a percentage. So, if your home is worth $700,000 and you owe $350,000 on your home loan, your loan-to-value ratio is 50%.
As property prices rise (as they tend to do over the long term), the equity in your home can also rise. You may have started out with a standard loan-to-value ratio of 80%, purchasing your property for $500,000 with a $100,000 (20%) deposit and a $400,000 home loan
A rise in your property value, along with reducing the amount you owe on your loan, will naturally increase the equity you have - in this case from 20% to 50%. At the same time, your loan-to-value ratio has reduced from 80% to 50%.
When refinancing to get a cheaper interest rate, a lower LVR will generally stand you in good stead. But if you’re looking to refinance with an LVR higher than 80%, you may struggle to qualify for the lowest interest rates on the market.
If you’re seeking to refinance with another lender, you may also face having to pay for Lenders Mortgage Insurance (LMI) – even if you already paid for it when you took out your original loan.
When refinancing to access some of your equity (for example, to pay for a renovation or to invest it in another property), you’ll generally be able to borrow up to 80% of the property’s value minus the outstanding debt.
So, if your property is worth $700,000, you would be able to borrow 80% of that, or $560,000, less the amount you owe on your loan, $350,000. That’s $210,000 in equity freed up from your home loan which could go some way for paying for renovations or another property.
Borrowing any more than that would push your loan-to-value ratio beyond 80% LVR which many lenders may not be comfortable with. But lenders' policies vary considerably. If you’re looking to refinance, it pays to shop around for a lender that best meets your needs and circumstances.
4. Credit rating
Have you checked your credit rating recently? If it’s not so great, you might find it working against your efforts to refinance.
Also, refinancing represents an application for credit, which also appears on your credit report and can influence your credit score.
Lenders can be wary of those who refinance too often, so having numerous mortgage refinances on your credit report can affect your interest rate bargaining power or indeed your eligibility to refinance.
5. Current home loan interest rates
It pays to be across what interest rates are doing in the home loan market and what a variety of experts are predicting. If interest rates are expected to rise over the next few years, you might want to consider refinancing to a fixed rate home loan.
A mortgage broker can provide some general advice regarding expected movements in the market, but it pays to do your own research before you decide to refinance. The table below can also help you find some of the lowest interest rates currently available on the market:
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.04% p.a. | 6.08% p.a. | $3,011 | Principal & Interest | Variable | $0 | $530 | 90% | 4.6 Star Customer Ratings |
| Promoted | Disclosure | |||||||||
5.99% p.a. | 5.90% p.a. | $2,995 | Principal & Interest | Variable | $0 | $0 | 80% | Apply in minutes |
| Promoted | Disclosure | |||||||||
6.09% p.a. | 6.11% p.a. | $3,027 | Principal & Interest | Variable | $0 | $250 | 60% |
| Promoted | Disclosure |
6. Honeymoon rates (or introductory rates)
Sometimes you can be lured to refinance your loan by an eye-catching introductory or honeymoon rate. This is an interest rate you will be paying for a specified period before the rate reverts to another (often higher) rate.
If that’s the case, make sure you are clear on what interest rate the loan will revert to at the end of the introductory period which can generally be between six months and two years.
You should also consider this for interest-only and fixed rate home loans. What will the rate revert to after the interest-only or fixed-rate period has passed? Sometimes it’s impossible to know what an exact variable rate will be over a longer time frame.
Again, do your research to see what the experts and the market are forecasting for interest rates over the longer term and take this into account.
In worst case scenarios, borrowers can face the risk of being stuck with a high revert rate and unable to refinance to another lender at a lower rate – effectively becoming a prisoner to their mortgage.
This could be because a lender’s lending criteria has tightened, the borrower’s credit score has worsened, or their property value has dipped (property values don’t always rise in a linear fashion), effectively raising their loan-to-value ratio (LVR).
7. Loan term
Think about what loan term you’re refinancing to – is it going to be longer, shorter, or the same as the remaining term on your current loan? Be wary that while refinancing to a longer term can reduce your regular repayment amount, the total cost of the loan can be more (because interest is accruing over a longer period).
Refinancing to a shorter term has the opposite effect. It will increasing your regular repayment amount but save you on the total interest payable.
8. Loan features
A loan with a lower rate doesn’t necessarily represent the ‘best value’. When refinancing to find a better deal, consider useful home loan features such as a redraw facility or an offset account.
These features, used effectively, can save you much more on the overall cost of your home loan than a lower interest rate alone.
9. Debt consolidation
If you have significant debts outside your mortgage, such as a car loan, personal loan, or credit card debts, you could consider consolidating these into your mortgage when refinancing.
This can make it easier to manage your debts because you’re repaying them all through the one regular repayment (weekly, fortnightly or monthly).
The consolidated debts will revert to the interest rate of your home loan, which may be significantly lower than the interest rates you were paying when they were standalone debts. Credit cards can have interest rates of more than 20% p.a.
However, beware, because of the longer term of a home loan, the total interest payable for the consolidated debts may work out to be higher. Again, you’ll need to do your calculations and consider what best suits your long-term goals.
10. Your timeframe
Are you definitely going to continue owning the property in the long term?
If you sell the property after refinancing to a lower interest rate, you may not have had enough time to accrue the significant interest savings required to make the refinance worth it.
Consider your longer-term plans for the property before going ahead with refinancing.
11. Your current lender
If you haven’t already, you should call your current lender before looking to refinance somewhere else. Many lenders have large teams on hand to retain their current customers because it’s much easier to keep one than find another.
To encourage you to stay, your current lender may offer you a better deal on your current home loan than what you were considering elsewhere or maybe waive some fees and charges to refinance to another of its loan products that may better suit your changing needs.
If you’re thinking of refinancing for whatever reason, your current lender is the logical place to start so don’t be hesitant to pick up the phone to negotiate.
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