The Refinancing Dilemma

By Nila Sweeney

Interest rates have fallen dramatically, making it a good time to refinance your
mortgage, right? It depends on which experts you ask. Kit Kadlec reports on what
signs you should look for and how to decide if refinancing is financially viable

Refinancing is a tempting option right now, especially for those with a fixed rate. In some cases, borrowers locked in rates at around 9% in 2008 only to see the variable rate at the same bank fall below 7% by December.

For those in such a situation, it's hard not to imagine what those lost hundreds of dollars per month could have been used for instead, especially in the worsening economic climate. Some may even see refinancing as a necessary step to hold on to their home.

According to the latest data from mortgage broker Australian Financial Group, more than 37% of the total loans sold in December 2008 were for refinancing purposes, as the official cash rate set by the Reserve Bank of Australia (RBA) dropped from 7.25% in March 2008 to 4.25% heading into 2009.
"If you can get a good rate now, it would be a good time to refinance with the drop in interest rates," says Lesley Wood, general manager of the Australia Loan Company.
"I don't think [interest rates] will go much further [down]. I don't think we will go as low as the US. Australia isn't in that economic situation."
Still, she pointed to some competitive fixed rates that were available in December that indicated lenders were expecting rates to come off further, some below 5%.

Does it make sense now?
While the timing may be right in general, there are pitfalls in refinancing, such as costly break fees, and it doesn't always make sense for an individual, as frustrated as they may be with their current mortgage, to switch to a cheaper product.

"The timing for a refinance is much more about the individual need than the environment," says BidMyLoan founder and CEO Declan Murphy.
He cited a BidMyLoan applicant who wanted to refinance a loan that was only six months old after a frustrating experience with their lender.
"The difficulty was that there was no real economic benefit to refinancing and the decision was being based on emotion rather than the cold rationale of numbers," Murphy says.
John Mohnacheff, managing director of BEAT Home Loans, says refinancing might be more popular now, but borrowers shouldn't let what others are doing be their sole influence.

"I always say refinancing for the sake of refinancing is probably not a smart idea," he says. "People need to work out what their net tangible benefit is before refinancing."

Mohnacheff recommends that the first step for someone considering refinancing should be to see a refinance specialist to work out the numbers.
"Do that just to make sure you are in charge of all the facts before you decide to refinance," says Mohnacheff. He adds that you should run the numbers "not just for the immediate difference, but for the long term benefit".

Exit fees vary, but can be in the thousands of dollars, so it makes sense to put it all out on paper and see where your bottom line ends up.

Check the signs
Before running the numbers, it might be a good idea to review some of the signs that could indicate now is a good time for you to refinance. Tracking interest rate movements is a useful and important indicator, says Wood.

Other than just checking to see if rates are going up or down, you should look for indications of what will happen in the future. Nobody has a crystal ball, but Wood says looking at how lenders are setting their fixed rates now can give you a good indication of what they will do in the future.
A lending institution's rates are set based on its experts' predictions of what the RBA's rate will do.

"If they are advertising, as Westpac was at 4.99% [for a three-year fixed rate in December], they believe rates are going to come down even more," Wood says. "When you're looking at it from a bank's perspective, what they are saying is: 'If we put an aggressive rate [now], we believe it will come down even more'."

The aggressive December rate was based on the expectation that the RBA was going to lower rates again in January. However, such predictions mayn't always be right. And banks don't always closely follow the RBA's moves. "We know that when the Reserve Bank drops interest rates, the banking institutions don't necessarily follow," says Wood.

A question of stability
But while such information can be important, there's also more than falling interest rates to consider.

It's not until the market stabilises, says Mohnacheff, that one can make an informed decision. And that hasn't happened yet.

"I'd always urge that you wait until the market has stabilised so you can make an informed, long-term decision," he says. "Refinancing right now in a market that is so volatile may not be your best option."

One concern might be that you select a lender that ultimately does not pass on the next big rate cut. What might be the best variable rate this month could seem a poor choice just a few months later.

"Unless there's a real pressing need, I'd use caution," Mohnacheff says.
That period of stabilisation might be a couple of months or as long as a year away, he continues.

Those thinking of refinancing should consider a lot of things other than just rates, adds Mohnacheff.

"At the moment, you have to watch everything," he says. "You have to be watching the stability of your own employment, watching the levels of debt that you have to commit to, checking what the share market is doing. And it comes down to what is going to be your net tangible benefit in refinancing."

Aside from national and global indicators, borrowers need to consider their own situation with scrutiny.

"You really have to look at your own employment stability," says Mohnacheff. "Company profits are down, there's uncertainty on the global markets. Be careful. Never assume that you are immune from being retrenched."

Sorting the numbers
If you do feel secure about refinancing, one of the key obstacles is the break cost, or economic cost, as it is commonly termed. The formula for calculating this fee, often complicated, is generally disclosed in the loan documents. The total varies from bank to bank.

It can add up to $10,000, $15,000 or, in some cases, $20,000. It's notuncommon to find banks that charge 1% of the loan amount. In many cases, that fee alone stops any thought of saving money through refinancing.

If you're not sure what your break fee would be, request a written quote from your lender. That way there won't be any surprises.

The costs you may face include:
• exit fees
• establishment fees
• application fees
• loan approval fees
• settlement and handling fees
• additional mortgage stamp duty
• mortgage registration

"You might think you've found a great rate, but you have to be very, very careful that you know what the exit costs will be," says Mohnacheff.

However, for those with a lower end break fee and who stand to save some two to three percentage points on their loan, there can be a massive benefit. You've got to look at the gap between the rate you will borrow at and the rate you're getting out of, says Wood.

"A lot of people do their figures about repayments and cost of the loan, and they look at how much it's going to take them to recover the break cost," says Wood. "Once they've done that, they might find it can be 18 months to two-and-a-half years before they are in a position where they've recovered."

For some borrowers, it might take just one year to break even, and in addition, they get the lower rate to continue saving. But with some lenders charging $10,000 or more in exit fees, such a scenario is not likely and refinancing then is often not recommended.

"As a rule of thumb, we recommend that a borrower would only consider refinancing if they can recoup the costs within the first year," says Murphy of BidMyLoan.

If you calculate that a rate change will save you about $350 per month but you'd have to pay about $10,000 in fees in order to refinance, it would take you about two years and five months to break even.

Lower the exit fee to $5,000 and you're down to a year and two months.
Conversely, raise the exit fee to $15,000, which some banks charge for breaking a fixed rate, and it's going to take three years and seven months to break even, if you're saving $3,500 per month with a lower rate.

However, if you're switching to a variable rate, consider the potential for this rate to rise or fall in the future. Your calculated savings might look good on paper, but these can be wiped away if rates start rising again.

In addition, rather than just chasing the lender with the lowest rate, consider a lender with the reputation for passing on RBA rate cuts to its customers.

Speak to multiple sources
You might get a favourable opinion from your broker about refinancing, but don't rely on just one person's recommendation, says Mohnacheff.
"You must sit down with several professionals, and not just a broker," he says. "Talk to an accountant, talk to some financial advisors. Get different opinions and don't just rely on one source."

Basing a decision just on speaking to one person is a mistake many make, says Mohnacheff.
"These are crazy times, so the more opinions you have, the more informed you become and the better your decisions will be," he says. "Finance opinions are different from what you'd get from an accountant, and different from what you'd get from a banker."

You can use the knowledge you pick up from each to both balance your perspective and give you some informed questions to ask along the way.
"At the end, we're going back to 'Research 101' here," says Mohnacheff. "You should [research] even in the best of times. But now it's even more important because the decision you make can be more costly. This is not gloom and doom. These are practical things you can apply all the time."
Even if you're not sure you want to refinance, doing the research is always worth it, says Murphy.
"The important thing is not to simply look at the available rack rates or initial offers, but to enter into the negotiation to identify the real savings," he says.
"If the savings are significant, then it makes sense to refinance. But if not, you get the comfort of knowing you have a
good deal."

Switching: fixed or variable?
With the expectations that rates would fall, fixed rate commitments in Australia fell to an all-time low late last year. In October 2008, just 3% of loans written were fixed rate, according to the Australian Bureau of Statistics.

That low level of interest, coupled with the falling rates, pushed lenders to drop their interest rates to very tempting levels. Once people start feeling that rateshave bottomed out, expect the numberof fixed rate commitments to sharply rise again.

However, those looking to lock in their mortgage at these lower rates should equally do a lot of homework beforehand.
"Those considering refinancing to a fixed rate should look at what the interest rate they are going into is, and what the variable rate it will automatically revert to is," says Wood.

"They should look at that and see if it's competitive. Also, see if there are additional fess and charges. These are commonly overlooked."

Wood says, however, that she advocates sticking to a variable rate."I definitely believe that they should ride with the variable rate. However, in this environment, if they can obtain a good three-year fixed fate, then I believe they should fix a portion of their loan."

That's not to say there aren't advantages in fixing, especially when rates are this low. But Wood says these advantages are often overstated.
"Most people want the security of, 'I know how much I'm going to pay'," says Wood. "They want the safety net of knowing how much their repayments are going to be so they can know how much they have to live on."
Murphy says he still hasn't seen much of a shift to fixed rates yet.
"The vast majority of BidMyLoan applicants are continuing to choose variable rate loans," he says. "I think this is because they are aware that the mid-term view from economists is for some further drops in interest rates followed by a flattening.
"However, if you are risk averse there are some really good fixed rates available right now. While you may end up paying a little more in the long run, you need to weigh this up against the comfort of knowing you have no exposure to higher rates if they do come."

Debt consolidation
Aside from saving on your mortgage repayments, refinancing can also help your overall economic situation.
Taking on a new loan to cover existing credit card debt can lead to major cuts in your interest payments. While credit cards come with interest rates of up to 25% in some cases, interest rates on mortgages can be as low as 6%.
"To me, that's highway robbery," says Mohnacheff of the credit card rates. "The cash rate is around 4% and they are charging 25%."
He says paying off credit card debt should be everyone's priority.
"If you can refinance and reduce your debt, fantastic," he says. "Pay them down, or refinance and pay them down."
Mohnacheff says America's sub-prime crisis has taught the lesson that it's not about accumulating debt, but rather reducing it.
"You have to keep an eye on your debt," he says.

How long does it take?
In the current climate, when the number of people refinancing has picked up significantly, you have to expect some delays beyond the usual two to four weeks for refinancing to be completed.
"It depends on the lender," says Wood. "Some of the second-tier lenders are quieter in terms of number of refinances and will go about this very quickly. But your major lenders are having a few problems with the back office at the moment. It's blown out the timeframes."
Still, Mohnacheff says a refinancing should never take much longer than a month to complete.
"If you can't get a refinance done and dusted from the time of researching within three to four weeks, there's something wrong," he says.
"Most of the time is taken up with research. Once that's done, there's no reason a settlement should take up that much time."
Murphy says it often depends on the efficiency of the incoming lender and the speed at which your existing lender provides the necessary paperwork.
"You can speed up the process by contacting your existing lender and following up on the paperwork," he says.
One factor can be the date of your last home appraisal and whether there are comparable homes in your area. A home appraisal is often what slows the process down.

Wood says staff reductions at some of the major banks in late 2008 also will play a part.
"I think some of the majors have reduced some of their staff when they thought things were slower, and with rationalised in those departments,"
she says.

"Now refinancing is starting to pick up again."
In the US, with interest rates at record levels, the environment has been described as a refinancing 'frenzy'. As Wood says, refinancing in Australia is not occurring at those levels. But should Aussie interest rates continue to fall, expect the refinancing field to explode with demand.
Murphy says it's important to always plan ahead and research how refinancing could help you.
"Start the process early to allow yourself plenty of time," he says. "You don't want to have to rush and end up making the wrong decision." YM