The refinancing decision

By Nila Sweeney
Even if you find a cheaper home loan than you currently have, you will not necessarily be better off if you make the change. There are a number of things that need to be taken into account when evaluating whether to refinance your home loan or not. Your Mortgage with Michael Lee reports.

A number of people refinancing their home loan in recent times have been changing from a variable interest rate loan to one with a fixed interest rate.

According to the economists and the money markets, interest rates appear to have bottomed. Fixing your home loan now may be a prudent thing to do if you need the security of a low interest rate and fixed repayments.

Many people also see greener grass on the other side of the fence and think about changing home loans. This includes a number of borrowers who are contemplating upgrading their loan to an all-in-one loan or a loan with a 100% offset account attached, plus others looking for a lower interest rate.

There are a number of things which need to be taken into account when evaluating whether to change home loans. Two important areas of consideration are the cost of refinancing and the different features associated with the two loans in question.

The big switch
The term ‘switching’ is generally used to refer to changing loan while remaining with the same lender. To do this you usually have to pay a switching fee. The fee to switch from a variable loan to a fixed interest rate loan is usually a flat fee.  

Table 1: Home loan switch to fixed fees

Institution Loan Switch to Fixed Fee
Homestar Homestar Fleximax Loan $125
One Direct Variable rate $200
Mortgage House Pure Basic $295
ING Direct Mortgage Simplifier $250
Heritage Building Society Basic Variable $450

Table 1 uses the example of a borrower who currently has a variable loan with the institution listed and switches to a fixed rate loan. For example, a borrower with a Homestar Fleximax Loan who wants to switch to a Homestar fixed rate loan would pay a switching fee of $125.

If you have a fixed loan it is likely that you will also have to pay a break cost to get out of it before the end of the fixed period.

Break costs
What if you fixed your loan a couple of months ago and are thinking about going back to variable?

If you wish to get out of your fixed loan before the end of the agreed fixed period you will probably have to pay a break cost.

Many borrowers looking to get out of their fixed loan often believe they are being hard done by when their lender quotes them a figure of several thousand dollars in exit fees. It is important to remember that when you enter a fixed loan, you are agreeing to make the set payments for the fixed period – and if you wish to break that agreement the lender expects to be compensated if they are disadvantaged.

Table 2: Fixed rate break costs

Institution Loan Break cost
St.George St.George three-year fixed $350
Pacific Mortgage Group PMG three-year fixed $2,095
Better Option Better Option three-year fixed $850
Westpac Fixed Options three- year $1.150
Homestar Finance Homestar three-year fixed $1.350

The exact way in which break costs are calculated varies between lenders. Under the Consumer Credit Code, lenders can only charge an amount which reflects the cost to them of you exiting the fixed loan. However, there seem to be different interpretations of this rule.

An understanding of why and when lenders charge a break cost can be gained from a simple example.

Say a borrower has agreed to a fixed-interest rate period of five years with an interest rate of 7%. After six months, the borrower wants to pay out the loan. At this point in time the interest rate on five-year loans is 6%. Basically, this means that if the borrower breaks the agreement with the lender and pays back the loan early the lender will be worse off. This is because the current borrower is paying them interest at 7% but a new borrower would only pay them 6%. See Table 2.

Changing lender
When you change lender, there are a number of additional costs that you will face.

You will have to pay a mortgage discharge fee, which covers the legal and administrative cost of closing the loan. Sometimes (but not always) you may have to pay this even if you stay with the same lender.

You may also be charged what is often called a ‘deferred establishment fee’. This is a flat fee charged if a loan is paid out within a certain period.

For example, Pacific Mortgage Group’s total exit cost is $2,095 if you pay off your loan within three years; but if the loan is paid out within five years the fee is $295. One Direct also charges $1,150 if you exit your loans within three years. This fee drops to $150 if you pay your mortgage in five years.

After paying to get out of your old loan, you then face the costs to establish a new one. Establishment fees, lender’s mortgage insurance and stamp duty on the mortgage contract need to taken into consideration.

Making the most of your position
Michael Lee of Mortgage Keyfacts says before you jump into a refinance, you must decide whether you are able to take advantage of the new level of competition and whether it is worthwhile making the switch. The trick to simplifying the comparison process is to spend a few hours getting organised. Lee explains how to do so below.

Form a view
In the absence of official data, industry watchers suggest mortgages are typically refinanced well before the end of their original term. Lenders penalise payouts in the first five years, which confirms that refinancing inside of this period is happening more often than they would like. It is reasonable to start with a basic that assumption the mortgage you establish today will be inadequate in three to five years.

Be diligent and move swiftly 
It is very important to make an informed decision, but it is also important to reach your decision within a few weeks of asking for mortgage comparison information (otherwise it might become outdated). This may affect your results dramatically and if extended delays occur, you should restart the process.

Tip: If the RBA has recently announced rate increases, ask your broker or lender to factor in the rate rise if it has not already been included in the current advertised rate.

Keep your apples together 
Although an apple-to-apple comparison is difficult, it is critical you achieve a basis for objectively comparing different options. Fortunately, as an investor focused on the return on investments, the simple answer is ‘bottom-line cost’.

While cheapest is definitely not always best, effective comparison requires bottom-line cost comparison based on your view. The use of advertised interest rates, comparison rates and hidden fees complicates comparisons. Ask your lender or broker to provide you with a bottom-line cost including individually listed interest, fees, and charges on either a three- or five-year exit. Fees should include all costs to get into, maintain and get out of their solution. Make sure you get it in writing.

If any fees are variable, ask for an estimate including any assumptions used in their estimate. This can help prepare you for variable costs such as lenders mortgage insurance (LMI) and mortgage stamp duty. LMI and mortgage stamp duty are often forgotten or underestimated when refinancing. When you apply for a refinance, your home will be re-valued to work out what percentage of your home you are borrowing against.

Usually if the loan is above 80% of the value of your home you will need to pay LMI on the new loan – even if you paid it on the previous loan. If the value of your home has increased, the chances of paying LMI may become slimmer and visa versa if your home has decreased in value.

Understanding the bottom line simplifies your selection process by helping you identify the cost of different solutions against promised benefits. If your lender or broker will not provide you with this information, you can avoid being tricked by simply avoiding them.

Warning: Setup and exit costs vary significantly loan to loan and lender to lender (ie, what they are called, when they apply and how much they cost you). Some setup costs and penalties are so severe that switching in less than five years can add upwards of 0.5% p.a. to the effective rate. Although these fees are not included in the comparison rate or advertising, borrowers often end up paying them or stay trapped in an underperforming loan.

One more chance
It is important to give your existing lender the first chance to retain your business and help you find out where you stand. As they know your situation, they should be able to look after you. However, your loyalty should stop there.

Offer your business out to other lenders directly or via mortgage brokers. This allows you to understand how fair your lender is being with you. If you find a better solution, take it. Your lender has profited from you since the beginning, and really should have taken better care of you.

Tip: A mortgage broker can make switching between lenders simpler by reducing the paperwork and the cost. Brokers that stand by their recommendations include satisfaction guarantees and share the cost of refinancing if things do not work out. A relationship with the right broker also means you are not left to start again each time you change lenders.

Step-by-step guide to refinancing

Step One – Make a wish list and prepare
To make your mortgage to work better for you, work out what you want it to do, then find a lender and loan offers the right fit. Sort the list from most important to least important. Work out features that are ‘must have’, versus those you might surrender if the price is right.

As an investor you might aim for:
  • Smart structures to maximise borrowing power based on income. Lenders have different methods of assessing different income and expense types which can affect borrowing power dramatically. For example, some lenders accept 100% of rental income, whereas others may only accept 50%.
  • A better deal on fees and interest cost. It is important to consider the impact of expenses on your ROI and the trade off you may or may not make for extra features or flexibility.
  • Competitive, flexible solutions for non-investment and investment borrowings. Facilities for non-investment borrowings are more likely to require greater access and flexibility options such as offset accounts. Just remember, these benefits might be reduced significantly when applied against an investment mortgage.
  • Conversion of equity to accessible cash to seize opportunity as it arises. If you think you will need accessible cash, then it should be arranged before you actually need it. Be warned, ready access to cash requires strong discipline to ensure it is invested wisely.
  • Separation of security. A mix of lenders may increase your borrowing power and keep your costs down. It also provides asset insulation in the event that a repayment problem occurs on one of your investments.
Step Two – Apply the blowtorch
Go to your current lender and apply the ‘one more chance’ approach. If they offer a better solution ask them to provide a written proposal based on your individual situation that explains:
  • Which products they recommend to you, along with the respective loan amounts and repayments.
  • The bottom-line cost, in dollars and cents, detailing all fees, charges, and interest based on either a three- or five-year exit. Fees and charges should include all costs to change the facilities and to terminate the loan (if necessary).
  • How their solution fits your wish list of needs and wants.
  • A full and accurate list of the fees and charges you will be charged to terminate your loans with them. By asking these questions, your lender knows you are serious and this encourages them to do their best. It also provides you with an accurate amount to factor into refinancing costs when deciding whether to stay or go.

Lenders interested in working with you should be able to provide you with this information within two business days.

Step Three – Check the market
Shop around with lenders directly or have a broker do it for you. A high-quality mortgage broker will provide you with an apple-to-apple comparison between loans and lenders as well as making the application and refinancing process simpler and more effective.

Make sure you provide the prospective lender or broker with the same information and requirements that you have provided to your existing lender. If you change your requirements, you should start the process again. This maintains a level playing field and improves reliance on bottom-line cost when comparing different options.

Money Saving Tip: Mortgage brokers receive commissions from lenders for arranging and continuing to support your loan. An increasing number of brokers share this commission with you to reduce the effective cost of your loan. Remember, your broker has an ongoing responsibility to you and you should ask how much they will contribute to your refinance costs if you need to.

Step Four – Weighing up the cost of your options
If you have done your work properly, you should now understand what you need from your mortgage solution and have a selection of loans that meet your needs to different degrees. You should also have a bottom-line cost for each of these options, which then enables you to ‘value’ features that are or are not included.

Sort each option into cost from lowest to highest, then work your way through the list until you find the right balance between cost and features. Remember to add refinance costs such as mortgage duty (varies state to state) and your current lenders discharge costs and penalties when comparing new lender options.

If your main reason for refinancing is to reduce interest cost, you should expect to recover the cost of refinancing within 18 months.

However, make sure you also assign value to other advantages such as increasing borrowing capacity, which allows you to take up opportunity, or getting better asset protection, which improves the security of your current investment strategy. How much this is worth is up to you.

When refinancing is not for you
Refinancing can benefit the majority of borrowers if the right help is found and a better overall outcome achieved. Switching, however, is not for all borrowers. If you have consolidated major debt into a refinance once before, it is time to seek professional advice on your debt ratio before your mortgage health.
If you are about to sell your home or investment property you should consider refinancing after the sale, as your circumstance may alter significantly.
Michael Lee is the spokesperson for Mortgage KeyFacts. Visit