Should you refinance your current home loan or stick to your existing one? This can be a difficult choice to make. Just because a better rate is available doesn’t necessarily mean you’ll end up saving money by switching home loans with your current lender or a new lender. However, if you do it right, you could end up saving large sums of money.
Thankfully, both banks and non-bank lenders are offering better refinance options. As refinancing now constitutes a sizeable chunk of the mortgage market, lenders want to attract borrowers who have a better financial education. This has led to more competitive refinancing options for Aussie borrowers.
While you’re looking at the available options, be warned: refinancing has its hazards and needs to be considered carefully before moving forward.
When refinancing COULD make sense:
- Your lender’s rate is no longer competitive
- A major change has occurred in your financial situation
- You’re looking for more money to pay for something major like a home renovation, a child’s education, or another property investment
- You want to switch to a fixed rate at an opportune time
- You’ve started accumulating large credit card debts and want to consolidate
- You might not own the property for much longer
- Prepayment penalties are high on the exiting home loan
- Since your previous loan, your credit history has taken a hit due to outstanding debts, making it less likely you’ll get a good rate
- You’ve don’t have a reliable source of income over the period of the loan (ex: You’re freelancing)
- Your loan balance is low and you don’t want to redraw on available equity
Also, think about the costs of switching to another lender. Miscellaneous fees to consider include the entry, exit, application, valuation, and stamp duty fees, as well as other ongoing charges.
Another factor is the security of your income. You need to consider how secure your job is or if you can manage the home loan on one wage instead of two. And borrowers should also be aware of the early warning signs that refinancing with a particular lender might not work out.
If something doesn’t feel right early on, it might be time to look for another lender. For example, if a lender is slow in approving your loan or doesn’t communicate well during the period when they’re trying to win your business, there’s a strong chance their service might not improve once they’ve gotten your business.
It’s also worth talking to your existing lender when considering refinancing with another lender. Some lenders might go to unexpected and extreme lengths to keep you, such as waiving fees, rather than letting you go to a competitor. That can be especially true if you’ve made all your payments on time and have been with that lender for a number of years.
If you approach another lender, it’s important to always present the best financial picture of yourself to them. Make sure you’ve paid off as much of your other debts as possible and drop unnecessary credit cards.
Unfortunately, those who want to refinance but have been late in paying their bills and owe considerable amounts on a credit card might not be able to find a lender who is going to offer very good rates.
When it makes sense
There can be many reasons to refinance: a job change influencing your financial situation, or a current lender’s loan rate that isn’t keeping pace with the competition. Perhaps you want to renovate your current property or invest in more real estate.
Even if there isn’t any specific reason you have in mind, it’s always worth weighing up the viability of refinancing from time to time. Over the years, loan products have improved and there are much better deals out there.
Every three years is a good time for you to reassess your home loan and compare it to other home loans on the market. By doing this, you can determine if a change will provide you with the flexibility you need, or if the fees and charges on your current loan are high compared to other products.
This timeframe allows you to manage your interest rate risk and avoid costly break fees.
If you have locked in all or some of your loan over a three-year period, it would be a good idea to start looking at least a few months prior to its expiry. Finishing off the three-year period will also ensure you minimise the “get out fee” charged by most banks.
Wanting a lower interest rate and lower repayments are some of the more common reasons to refinance. It can be frustrating if your lender increases the interest rate on your loan by more than was set by the Reserve Bank. Other lenders may raise or lower their interest rates out of cycle with the Reserve Bank.
Even a slight increase or decrease in your interest rate can make a major difference in your repayments. Others who are looking to refinance might just want to fix their repayments, especially if rates have already bottomed out or will soon.
Another reason to refinance your home loan might be to consolidate your debts and only have one monthly repayment. If you have multiple debts from various sources (such as home loans, personal loans, credit card debt, or other high interest loans) and you’re having trouble paying these off, then it could make sense to roll these debts together with your home loan. The main advantage here is that your home loan rate is typically a lower rate.
Some credit cards have rates as high as 20% or more, which is more than double what you’d find with a home loan rate. The key is to make sure you don’t lower your repayments once you’ve consolidated. The same is true if you manage to get lower interest rates on your variable home loan. The savings this provides should be used to pay off the loan faster, so don’t be tempted to use this as spending cash.
Some borrowers also want to refinance to use the equity in their home to pay for home improvements. Keep in mind, while allowing you to expand your property portfolio or value, it will also greatly increase the loan term.
Also make sure when you refinance that you will be in a home you’d like to stay in for a fairly long period of time. Moving house shortly after refinancing could mean you might not be able to take advantage of the cost savings.
When it doesn’t make sense
There are some situations where refinancing should be avoided. You shouldn’t refinance while chasing slightly lower rates if you’ve built a good relationship with your original lender.
In these circumstances, chasing a small reduction in interest rates may prove to be a mistake. Like other industries, you get what you pay for. Going to a new lender for a small rate reduction may mean you are not looked after once you’ve made the switch.
Also, consider how long into your loan you are. If you’ve been paying your loan for 20 years already, refinancing to a longer loan term will reduce your payments in the short term, but will cost you many more years, and thus, more money.
Calculations must also be made in terms of prepayment penalties on some home loans. If you have a penalty on your existing loan, weigh that cost against any savings you would make. Refinancing is not for everyone. If the current rate on your loan is comparatively low, there is no benefit to be had from refinancing. In fact, you may end up incurring more costs when exit and other administration fees are taken into account.
If the current balance of your loan is already low and you do not intend to redraw on the available equity, then refinancing is usually not very beneficial.
Find the break-even point, which is the amount of savings on the rate necessary to make up for any penalty fees. Some exit fees from loans can be more than $1,000. That value might make the difference for some in determining whether or not they want to refinance.
Those considering refinancing should also consider how their taxes play into the equation, especially for borrowers with an investment property.
Unless a loan for your investment property is borrowed against that property, you are unable to claim a deduction for any expenses that are incurred while the property is being rented out. With that in mind, it is important to always seek advice from your tax professional in order to maximise such deductions.
You also always want to make sure you are operating under the rules of the Australian Taxation Office. Shop around, crunch the numbers, and make sure whatever you do makes financial sense over the long run.
This guide was originally written in November 2015 and was updated for style and accuracy in December 2017