refinancing to a lower rate or to access equity needs to be weighed very carefully to ensure you’re getting the desired savings or outcome. Here’s how we help you crunch the numbers.
Unfortunately time doesn’t stand still. While you may have found the perfect home loan solution five years ago, it is almost guaranteed that your mortgage is out of sync with the 2010 market.
So, if your mortgage no longer fits like a glove, why not think about refinancing to one that does?
The average interest rate is still lower than the long-term average and competition is starting to ramp up in the lending market. You’re not only likely to negotiate your way into a cheaper rate, but you’ll have the opportunity to review the loan features that are best suited to you as a borrower.
According to the latest data from mortgage broker Australian Financial Group (AFG), more than 36% of the total loans sold in January 2010 were for refinancing purposes, as the official cash rate set by the Reserve Bank of Australia rose from record lows of 3.25% to 4% since October 2009.
Phil Naylor, CEO of the Mortgage & Finance Association of Australia (MFAA), says although a lot of the competition within the Australian mortgage market has been squashed by the economic downturn, there is still ample opportunity to refinance to a suitably more cost-effective mortgage.
“It’s still a good time to look within the market for a more appropriate home loan,” says Naylor. “What might have been the right loan for you two to three years ago may not be today. Your income might have changed, you might have started a family or the kids may have moved out of home. So it doesn’t hurt to ‘health check’ your mortgage and make some enquiries about what products are out in the marketplace.”
For fixed-rate borrowers who locked in mid-way through 2008 it might sound like a pretty good step to refinance. And while the interest rate environment might be primed for great rates, the downsides to refinancing, such as costly break fees, can outweigh the benefits.
No matter how frustrated you may be with your interest rate or lender, refinancing doesn’t always make sense for every borrower. Researching your options before going ahead with the switch can save you thousands of dollars.
How does refinancing work?
Refinancing enables borrowers to rewrite their current home loan with a new one, with the aim of obtaining a lower interest rate, or for more suitable loan features and structure.
You can either refinance with your existing lender or choose to switch to another lending institution altogether. Once you have made your decision to refinance and chosen the right home loan solution, your new lender will pay out your existing lender with some or all of the funds from your new loan.
First point of call
Before refinancing, consider your current financial situation along with your goals for the next three to five years. This is the best way to prevent the need to refinance any time again soon.
One of the keys to making a refinance work is not only reducing repayments via lower rates in the short term, but also ensuring these rates will be competitive for the next five to 10 years as well.
It is worth seeking the advice of a good mortgage broker to get this requirement spot on.
In order to plan for your refinance you must pinpoint what is important to you within a home loan. Is it:
- a low rate
- with no ongoing fees
- offering good support and service
- a short loan term
- secure against rate rises?
After you’ve decided what you want out of your new home loan, approach your existing lender to see if they can better your deal. If you’ve got a no-fuss history your lender might go to unexpected lengths to keep you, such as offering an ultra low interest rate and waiving fees. If this happens make sure you get all offers in writing so you can use this information against your comparison of the market later on.
If you use a broker to negotiate your refinance their first stop is working out whether you can reduce exit and entry costs by facilitating the refinance with your existing lender, and pull a few strings there.
Brokers tend to have significant numbers of customers with each lender and they know how far they can push to avoid you having to switch lenders altogether.
Go into your refinance with a clean slate. Attempt to pay off as much personal and consumer debt as possible and reduce your credit card limits to manageable levels.
Why make the switch?
Contrary to common belief, a low rate isn’t the only reason a borrower would choose to refinance. They might make the switch due to lender dissatisfaction, debt consolidation, a need for further flexibility or even out of desperation to reduce their monthly outgoings.
“Borrowers have different things changing in their life that encourage them to change the style of loan they have. At present this might be the change in the economy that is affecting the way their mortgage works for them,” says Naylor.
“One of the factors going forward which will affect borrowers and encourage – or discourage – them to look for a better deal elsewhere is the dark cloud looming around unemployment, because changes to your employment situation can make it hard to have your refinance approved.”
Naylor points to the recent MFAA/ Bankwest consumer research showing that the most popular reason for refinancing in the past few months has been home renovation. This was followed by the desire to buy an investment property, buying a new home, the need for more funds and then a more compelling deal/rate.
Another reason you might choose to refinance is if you are about to – or recently have – exited a fixed rate product with a high variable revert rate. Others may want to take advantage of bottomed out rates and secure themselves in a fixed rate loan.
Debt consolidation – getting it right
It is a common event for borrowers to refinance so they can consolidate consumer and personal debt into their home loan. For many borrowers, this is seen as an easy fix to make large amounts of debt ‘go away’.
It is important to know that if you’re considering debt consolidation there is a right way and wrong way to go about it.
A good option is to ask your mortgage broker or lender to synchronise but retain the consolidated debt as a ‘split’ separate to your original home loan. You’ll be paying the same interest rate on each split, but via separate repayments.
This is a great way of reminding debt consolidating refinancers that their debt did not just disappear into the abyss, to help prevent them from falling into the trap of racking up more debt now that their slate has been wiped clean.
Many borrowers just continue to pay the minimum due on the mortgage and then run up a new debt on their credit card, and within 12 months they’re right back to where they started, but with a much bulkier home loan by their side.
"Consolidating debt as a separate split is a reminder of how vulnerable you are to letting credit get the better of you. It also helps you see how quickly you are (or aren’t) fixing the problem,” says Michael Lee, founder of KeyFacts.
“Also, even though refinancing will probably reduce your minimum monthly required payment, you should aim to keep your payments at current levels to make sure you are actually taking advantage of the lower interest rate.”
Here is an example of the right and wrong ways to refinance to consolidate your debt:
Jennifer has a home loan of $400,000, with monthly repayments of $2,000. Her home is worth $600,000. Jennifer also has several personal debts that she is struggling to repay each month.
The right way to refinance Jennifer’s debts is to obtain a new loan for $424,000 and split her new mortgage into two facilities:
1. One loan of $400,000 – she maintains repayments of $2,000 per month on the original loan.
2. One loan of $24,000 – she makes the minimum repayment ($200 per month). Make repayments of $1,000 in addition per month to quickly reduce the debt. Put the extra $320 per month into a savings account, or use it towards living expenses.
The wrong way to refinance Jennifer’s debts is to obtain a new loan for $424,000 and repay the new minimum payment due of $2,000 per month. Spend/save the additional repayments she no longer has to fork out each month on minimum balances, and watch her credit card balances rise again.
When refinancing doesn’t make sense
In some cases, it just doesn’t pay to refinance. If you’ve only been in a loan for a short period of time (for example six months), or your home loan is under $150,000, or it has been proven that you’ve got a good deal where you are, it’s probably not the best choice to refinance to another loan product or lender. If you’ve been paying your loan for 20 years already, refinancing to a longer loan will reduce your payments in the short term, but draw out your home loan and interest repayable.
Being that we are currently benefiting from a low interest rate environment, many borrowers (usually upgraders) are now choosing to refinance to a bigger home loan because it appears to be a financially savvy move.
Naylor says this is actually a trap, and borrowers should only refinance for this reason if they can prepare themselves for rising rates. “interest rates can easily go up to levels experienced in 2008 and if this happens some of these refinancers would be in a huge amount of strife if they didn’t prepare for it,” says Naylor.
“You should always add at least 2%+ onto the refinanced interest rate to see whether you can comfortably pay that if the time came.”
Weighing up the costs of refinancing
Your choice to refinance should always come down to the cost effectiveness of the move. Although it is worth giving your mortgage a ‘health check’ every three years, just remember that you may not need to refinance at all.
The economic costs of refinancing will include:
- exit costs and deferred establishment fees – sometimes quite hefty
- new establishment/application fees
- loan approval fees
- settlement and handling fees
- additional mortgage stamp duty
- additional LMI
- mortgage registration
- account fees on a new loan
For a refinance to be most beneficial, Naylor says borrowers need to assess their mortgage as a whole, revisiting their current choice of features and characteristics.
“Look at what your circumstances were when you first took out your mortgage and see what’s changed in your life, in your personal financial circumstances and the economy,” he says.
“If things have changed considerably it is time to reassess the effectiveness of your home loan package. In regard to the interest rate at least, it will most likely weigh up as a good time to refinance.”
As a golden rule, borrowers should only really consider refinancing if they can recoup the costs within 12 months.
“Don’t refinance when the exit and entry costs outweigh the benefits in the short to medium term,” says Adrian Lee, contact centre manager, Loan Market Group. “And this is likely to be the case most with fixed rates at the moment.
In most fixed-rate cases it will be best riding out the fixed-rate term due to high exit costs that could go beyond $20,000–$30,000.”
In terms of interest rates, Lee says it is only worthwhile to refinance if you can get at least 0.75–0.8% off your current rate.
Keeping those finances healthy into the future
Once you refinance to a more suitable mortgage product you really need to make sure you reassess the health of your home loan every few years, in order to make it work hard for you.
If you have consolidated debt, just remember to keep the consumer and personal debt to a minimum and continue to pay as much surplus into your home loan account each month.
“It is always good practice to pay more than you’re required into your loan account if you can afford to,” says Naylor. “If you achieve a substantially lower rate as part of your refinance, it is best for you in the long term to continue paying the higher repayment as you would have on the previous loan term.”
Borrowers with investment properties should monitor the difference between the property value and the remaining loan balance after refinancing.
If your property starts to appreciate in value you can access the equity in the property for further investment, by refinancing again or by topping up the current facility.
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