If you're not getting a competitive deal, moving to a new loan or new lender could be on the cards. Sarah Megginson reveals practical tips to ensure you come out ahead when refinancing
There are plenty of reasons why people chose to refinance their loan - to benefit from a lower interest rate, switch to a different product, access equity to finance renovations or access equity for a deposit on an investment property.
"You can refinance to a better
overall loan; however, what that means to each person is quite individual," says Trent Lee, managing director, Mates Rates Mortgages.
"You should always try to wind up with a lower overall cost and a loan that has the right features for you."
Whatever your motivation, Lee believes you shouldn't rush your decisions when refinancing.
"You need to make sure that you understand the cost of refinancing, and work out how long it will be until you get back out in front. You should also weigh up a couple of options, including staying with your current lender," he says.
If you're not sure whether you're getting the best deal on your mortgage, right now is the time to health check your loan and compare it to other products.
Borrowers commonly refinance so they can consolidate all of their debts, such as their mortgage, car loan, credit card and personal loan into one credit facility.
While this is a common strategy, Lee says there is definitely a right way and wrong way to go about it.
"If you decide to consolidate your debts, you should ask your broker to synchronise but maintain the consolidated debt as a 'split' separate to your original home loan," Lee says.
"A 'split' has its own statements and repayments, but it has the same interest rate as your main mortgage. This helps you to avoid one of the biggest problems for most people -out of sight, out of mind."
This happens when you consolidate your personal debts into your home loan, and then - because the smaller amounts have disappeared into a much larger mortgage - you "inadvertently slip back into bad habits".
You continue to pay the minimum due on the mortgage and then run up a new debt on your credit card. Within 12 months, you're right back where you started but with a much bulkier home loan to pay off.
"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 are not fixing the problem," Lee explains.
"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."
If you want to consolidate your debts, make sure you do it the right way. Take a look at the example above, which compares the right and wrong way to consolidate your debts.
In recent years, borrowers have tapped into the equity in their home for a whole host of reasons - to use the funds as a deposit on an investment property, renovate their home or upgrade the family car.
Today, however, accessing the equity in your property is not as easy as it once was, says John Smith, CEO, Inspired Finance Group.
"There are many variables to be taken into account, and it very much depends on the lender, the borrower, the type of loan and the urgency of the loan as to how successful you'll be at the moment," Smith says.
The primary issue revolves around the property's value. To have equity to access in the first place, your property needs to be worth more than your loan.
If you have a loan of $200,000 secured against a home worth $370,000-400,000, you have a strong equity position of $170,000-200,000, and you should therefore have no trouble securing additional funds through refinancing.
However, if you have a loan of $330,000, lenders may be less inclined to increase your mortgage. Assuming your property is worth at $370,000-400,000, a conservative bank valuation might bring the value down to $360,000, leaving you with an equity position of just $30,000 - less than 10%.
"Once a low valuation has been received it's virtually impossible to get them to change the valuation, because at the end of the day, for you to get comparables that prove they got it terribly wrong is difficult," Smith says.
Only consider this option if you're confident that the value of your property will stack up. "Call several valuers and ask them to give you a general idea of what they think about the area, and what you could expect them to value your property at," Smith says. Once you ascertain a worst case valuation figure, decide whether refinancing to access equity is the right move for you.
Switching to a lower rate
If you're chasing a lower interest rate, the golden rule to remember is that they fluctuate constantly - so one of the cheapest rates available today may become one of the more expensive rates in six months' time.
Banks and non-bank lenders increase and decrease their product rates at their own discretion, so a small rate differential shouldn't be enough to prompt you to switch.
Certain lenders, however, have been frugal in passing on the RBA's recent significant rate cuts. Some borrowers are still paying variable interest rates of 8-9%, and those are the borrowers that should be first in line to call their current lender for a frank chat, says Lee.
"If you think you're being hard done by, find out a little bit about the lenders that you think are offering a better deal, then pick up the phone and talk to your lender," he says.
If you discuss with your lender your intention to move to another lender, your current lender might offer a rate discount or suggest a more suitable low-rate mortgage from its product range.
Not satisfied with the response? Start shopping for a better deal, Lee says, because there "will always be a competitor offering a lower interest rate".
Approach your lender first and make sure you're getting the best possible rate from it - and if you're not, speak to a broker to see what options are available, Lee says. "A good broker has better buying and negotiating power than an individual borrower. They offer the lender repeat business - and this will be reflected in your effective rate."
Moving to another lender
The Australian mortgage market is flooded with financiers, from large banks to credit unions, building societies and non-bank lenders.
The one thing they have in common is that they all want your business because, despite the credit crunch and subsequent conservative lending policies, lending money is how they generate profits.
"Lenders are always motivated to retain your business - that's why so many of them have such nasty penalties for leaving them," Lee says.
If you decide to move to a new lender, make sure you read the fine print of your current contract first - your bank could slap you with all kinds of fees for leaving, including deferred establishment fees, exit fees, settlement fees and account closure costs. These can run into thousands of dollars, especially if your loan is relatively new. Deferred establishment fees, for example, are usually applicable if you close your loan within four years, and these alone can cost between $800 and $3,000, or more, depending on the value of your loan.
You also need to consider that your new lender will value your property when processing your application, and in the current market there is the risk that they will cautiously value your property for less than your current lender's valuation.
"Lenders are more conservative nowadays than what they were, say, 24 months ago," says Ken Sayer, managing director of Mortgage House.
Don't refinance with a new lender simply to access a cheaper interest rate. Instead, look at the overall cost of moving including all fees and charges before you switch.
From low-doc to full-doc
Lenders presently consider low documentation (low-doc) borrowers to be riskier propositions than full documentation (full-doc) borrowers. High risk loans often have higher interest rates attached, so low-doc borrowers should carefully evaluate their mortgage and their financial situation at the time, Smith says.
If you can prove stability in your job and your finances with a solid paper trail, you may be able to switch to a full-doc loan with your own lender.
"A borrower can go from a low-doc loan to a full-doc loan by providing financials for one to two years, depending on the lender. There may be a lower interest rate or other benefits gained from going from low-doc to full-doc, but this very much depends on the lender," Smith says.
According to Sayer, the paperwork involved can be substantial, but if a rate saving of 1% or more is on offer it's worthwhile chasing it up.
"The borrower would be required to provide current financial statements, including individual tax returns for the last two years and any company, partnership and trust returns where income is derived via these means.
Profit and loss statements may also be requested in some instances,"
Sayer explains. However, he says for your trouble you will "almost certainly attract a lower interest rate".
If you move from a low-doc loan to a full-doc product, you may stand to gain huge interest rate savings. But even if you don't access a rate saving, you may benefit from other advantages, such as lower ongoing fees or more flexibility.
Current risks when refinancing
The turbulence in the Australian and global economies has been the cause of more than a few headaches for borrowers and lenders alike. For those who are considering refinancing, Smith says there are a number of risks you need to watch out for. Here are just three of these.
Valuations represent one of the biggest challenges facing the property market in 2009 because, at the moment, "people still believe that their properties are worth more than they actually are", Smith says.
He suggests that you get "at least three quotes from real estate agents"
to try to determine the real value of your property, because lenders and valuers
are increasingly erring on the side of caution.
"I've heard of one lender who was telling valuers to be conservative, and then the valuers themselves can see the falling market. So to protect themselves they would be a little more conservative [in addition]," Smith says. "During the last month I have had four valuations that have come back lower than expected."
When people are fearful or unsure how to proceed, they are more vulnerable to being talked into doing something they don't entirely understand, Smith says.
"Don't even think about refinancing until you understand the benefits you'll receive over the costs involved in doing the refinance," he explains.
He suggests that you:
- ask your current lender what costs would be charged if you were to break the loan
- ask your broker what the costs are to take the new loan
- calculate the difference in rates, and work out an annualised saving
"Then it's just a simple matter of adding the savings and deducting the costs to see the benefits," Smith says.
"Benefits may not actually be savings, but things such as access to new loan features or further cash equity - but at least by doing this, you can see the real cost of the benefits gained."
If you currently have a high borrowing ratio - that is, the amount of your loans equates to more than 80% of the value of your property assets - then there's a chance that you are currently in or near a negative equity situation.
Negative equity in itself is not a huge problem, but it becomes an issue when you are forced to sell or refinance, which will formalise that loss.
"If you refinance through the bank that you currently have your loan through, the valuation may come up low and reveal that you owe more than the property is worth or that the LVR was too high," Smith explains.
"Then, under your loan agreement, you may be technically in default of your loan, and your lender can ask you to repay the loan, or at least repay a significant amount, to bring the loan back to a lower LVR."
If you are highly geared or you're concerned that your property's valuation might have slipped, you best move would be steer clear of refinancing for now.
Want the right loan? Ask the right questions
Can I make interest-only payments?
An interest-only payment option is primarily applicable for investment loans, says Robert Projeski, the managing director of Australian Mortgage Options.
However, he adds: "It doesn't hurt to find out whether you've got the option of making interest-only payments on your mortgage, should a loss of income situation or other unforeseen circumstance arise."
What are the fees, if any, for paying out my home loan early?
If you make extra payments or pay out the loan before the term is up, you want to know upfront that you won't be penalised for doing so.
"If you're working hard to reduce your loan and the amount of interest you're paying, the last thing you want is to be hit with excessively high penalty fees as result," Projeski says.
"Some lenders don't charge application fees, but they charge additional fees at the end [of the loan term] or when the borrower exits their loan. Look at this closely, as these fees can make a cheaper loan much more costly in the long run."
Can I get an interest rate reduction?
Lenders offer special packages called pro-packs, so called as they were originally targeted at professional people, which may offer a reduced interest rate, allow for a lower deposit or waive application or settlement fees.
"Some lenders also offer cheaper rates to their shareholders - so if you do hold investment interests in a bank or lender, ask about their investor packages," Projeski says.
Is the loan fully transferable to other properties?
"A loan is usually calculated over 25 years, but the average time spent in a property is often far less than 25 years - it's more like seven years," Projeski explains. "So it's conceivable that, during the life of the loan, you may be changing properties twice or more. Each time you do this, there are costs associated, hence, transferring the security of your loan from one property to another is a valuable option to have."
Can I have an offset account linked to the loan?
If you hold savings of any decent amount, these can be taken into consideration in an offset account linked to the loan. "The amount in your savings account effectively reduces the amount you are being charged interest on, which has the effect of reducing the amount payable, and also the time it
will take you to pay off your loan," Projeski says.
Can I make additional or more frequent repayments?
This is a handy option for reducing the loan term and the total cost of your mortgage. One thing it allows you to do is make lump sum payments."It's especially suitable if you receive dividends from other investments, tax returns or other lump sum amounts, such as bonuses or end-of-contract payments," Projeski adds.
Step-by-step guide to refinancing
Step 1: Find out the costs
Make sure you're aware of the costs involved in refinancing. Your first step is to see if any fees will be payable to your current lender, such as deferred establishment fees (DEF), when you refinance. If you refinance with the same lender, the DEF is usually waived.
Step 2: Check your motivation
Why do you want to refinance? Is it to access a lower interest rate, switch to a different product that your current lender won't provide or streamline all of your loans with one lender? Once you have determined why you're refinancing, you can decide what type of product and lender will suit you best.
Step 3: Choose the right mortgage
This is your opportunity to find the best deal on the market. Whether you approach lenders directly or go through a broker, you should create a shopping list of the features you want - low rate, offset, redraw, etc - before you approach lenders, so you don't get talked into more expensive products that offer benefits you don't need.
Step 4: Apply to refinance
Once you've decided on the loan you want, you need to submit an application. This process is similar to when you applied for finance the first time around, unless you're refinancing with the same bank - in which case, you won't need to provide as much paperwork.
Step 5: Inform your current lender
If you are refinancing to a new financier, you need to inform your current lender of your decision to refinance, so they can forward all required information to your new loan provider.
Step 6: Pre-approval
The new lender will take anything from a few hours to a few days to process your refinance application, at which point it will provide you with a pre-approval certificate stating that your application was successful.
Step 7: Valuation
Your new lender will arrange to value your property. If you're refinancing more than one property, your new lender will require that all properties are revalued. Generally, the first valuation is free, but the lender will often charge $200-300 for valuations on any additional properties.
Step 8: Finance approval
Your lender will advise you in writing of your loan approval, generally called 'formal' or 'unconditional' finance approval. Your broker or lender will then instruct a solicitor to prepare the loan documents on the lender's behalf.
Step 9: Legally binding
The documents will be sent to your solicitor to review and for you to sign.
Step 10: Arranging settlement
Your new lender will arrange both settlement of your old loan with your previous home loan provider, and the establishment of your new loan. This involves exchange of titles and the bank's registration of the mortgage over your property.
Step 11: Drawdown
You now have a brand new loan! You should receive details on how to manage your new loan, along with all of your new account information, within one week.