Secrets to successful refinancing

By Nila Sweeney

Dissatisfied with your rates or seeking better customer service? You're not alone.

There are always plenty of borrowers looking for a better deal. But while it might look like a good idea at first glance, refinancing has its hazards and needs to be considered carefully before going forward.

Despite the smaller number of players in the mortgage market, competition is still alive and well in Australia as shown by the recent flurry of rate cuts among lenders to grab market share.

Tony Beck, head of corporate and social responsibility for Members Equity Bank says that lenders such as Members Equity have managed to stay competitive through access to a diverse range of funds. Other lenders with similar diversity are still running business as usual as well. But even with better rates at some of the more secure lenders, not many people are comfortable shifting right now.

"Lenders are more than happy to refinance good quality loans from other banks," says Beck. "What we have however witnessed is a reluctance of borrowers to move during these uncertain times."

Michael Quinn, director of the legal and financial services provider The Quinn Group, says that the credit crisis can be the result of three misconceptions – that a borrower’s creditworthiness was in a strong position, investors were sophisticated, and that the credit risk was widely distributed. Many have thus recently tightened their lending standards.

"Whilst refinancing is a necessary tool for borrowers who have been hit hard by the credit crisis, it’s currently not as easy as it once was as banks are holding their dwindling funds close to their chests," says Quinn.

What to first consider
Before refinancing, a borrower should consider their circumstances for the next three years. Beck says that one should ask whether flexibility, a lower rate, fees or assistance is the goal.

Just chasing one interest rate won't be enough. You need to think about the entire life of the loan, not just the headline interest rate. Also think about the costs for changes to your lending.

"Some of the most important things for borrowers to be aware of when considering refinancing include the impact of any fees that may be applied, such as entry, exit application, valuation, stamp duty and legal fees, as well as any other ongoing charges," says Quinn. "It's also wise to consider the term of the loan, as this can significantly impact long-term financial obligations, as can whether a fixed or variable rate is selected."

Another factor is your own income security. Some analysts were predicting Australia’s jobless rate of 4.3% in September to double to 9% by 2010. The slowing economy in China, Australia’s largest trading partner, is a key reason.

"As the economy slows, you will need to consider how safe your job is or if you can pay the home loan on one wage instead of two," says Beck.

Borrowers should also check for some early warning signs whether refinancing with a particular borrower might not work out. If something doesn’t feel right early on, it might be time to look further.

"If they're slow to approve your loan, or don't communicate well during this period when they're trying to win your business, how bad will it be when you're hooked in?" asks Beck.

It's also worth talking to your existing lender when considering refinancing with another. Some lenders might go to unexpected extremes 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 some time already.

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 all unnecessary credit cards.

Those who want to refinance, but have been late on bills and owe considerable amounts on a credit card, might not 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, a current mortgage lender's loan rate that isn't keeping pace with the competitors, you want to obtain even more real estate, or perhaps renovate what you already have.

"In light of the current credit crisis, the most common reasons that borrowers are looking to refinance are that they wish to amalgamate multiple debts or loans from various institutions that may also have a range of varying interest rates," says Quinn. "Additionally, as interest rates are currently on the decline, it's becoming more of a viable option for those who may have previously fixed their interest rates at a higher level to consider refinancing to take advantage of the current rates that are on offer."

Even if there isn't any specific reason you have in mind, it’s always worth weighing the viability of refinancing from time to time. Over the years, loan products have improved. There might be a much better deal out there.

About every three years is a good time to fully reassess one’s rate and compare to other products in the market, says Beck.

"By undertaking this, you can determine if a change will provide you with the flexibility you may now require, or if the fees and charges are high compared to the rest of the market," he says. "This timeframe allows you to manage your interest rate risk and avoid costly interest break costs."

If you've locked in all or some of your loan over a three-year period, it would be good to start looking at least a few months prior to the expiry.

"The three-year period will also ensure that you minimise the 'get out' fee charged by most banks," says Beck.

Wanting a lower interest rate and lower repayments is one of the more common reasons to refinance. Many borrowers recently have been frustrated that their lender hasn’t passed on the full savings from lower interest rates set by the Reserve Bank of Australia (RBA), while other lenders have.

Even a slight difference in your rate can make a major difference over a long period of a loan.

Others looking to refinance might just want to fix their repayment, especially if they sense rates have or will soon bottom out. A record low number of Australians fixed their rates in August, less than 5% of all home loans, on expectations that rates were still falling.

Time has proven that the borrowing majority were correct over the short-term, with the RBA dropping rates by 125 basis points since then. Rates are expected to fall further into 2009, however, there’ll come a point when those rates will eventually stop dropping and go back up. That’s the best time to fix, but it’s not always easy to predict.

Another reason might be to consolidate your debts. If you've got a credit card bill you’ve been having trouble paying off, or other high interest loans, then it could make sense to roll these debts in together with your home loan. That’s because 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.

"For borrowers who have multiple debts from various sources or institutions such as a home loan, personal loan, or credit card, it may be a wise choice for them to refinance and consolidate all their debts into one monthly payment," says Quinn.

When it doesn't make sense
There are some situations where lenders should avoid refinancing, if possible.

You shouldn't refinance while chasing slightly lower rates if you’ve already built a good relationship with your original lender, says Beck.

"In these circumstances, chasing the extra small reduction in interest rates may prove to be a mistake," he says. "Like other industries, you can get what you pay for. The small reduction in interest rates may mean you're not looked after. If this means you miss an opportunity, then chasing the rate down would have proved costly."

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 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 such a penalty on your existing loan, weigh that cost against any savings you would make.

"Refinancing isn't for everyone," says Quinn. "If the current rate on your loan is comparatively low, there's 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."

Quinn adds that if the current balance of the loan is already low and you don’t intend to redraw on the available equity, then refinancing is usually not very beneficial.

Find the break-even point – 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.

The key is to make sure you don't lower your repayments once you’ve done this. The same is true if you get lower interest rates on your variable home loan. The opportunity with the savings should be used to pay the loan off faster, not to get more spending cash.

Some borrowers also want to refinance in order to use some home equity to pay for home improvements or other reasons. Keep in mind, while allowing you to expand your property portfolio or value, it will also greatly increase your loan period.

Do also make sure when you refinance that you’ll be in a home you’d like to stay in for a fairly long period of time. Leaving shortly after refinancing could mean you might not recover the costs.

Tax considerations
Those considering refinancing their home should also consider how taxes play into the equation, especially with an investment property.

Unless a loan for your investment property is borrowed against that property, you won’t be able to claim a deduction for any rental expenses that are incurred, says Quinn.

"So by refinancing an investment property loan, you can potentially deny yourself a sizeable tax deduction," he says.

With that in mind, it's important to always seek advice from your tax professional in order to maximise such deductions. You'll also always want to make sure that you're operating legally, says Quinn.

Shop around, crunch the numbers, and make sure whatever you do makes financial sense over the long run.


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