Your Mortgage explores some of the factors you need to consider before taking the plunge and refinancing your home loan.
What’s in it for you?
A 25- or 30-year mortgage can seem like a life sentence, particularly if you rush in and end up with a deal that’s not quite as good as it first appeared. High interest rates and fees can be punishing, particularly in the early years of a loan when expenses are high. The good news is you’re not stuck with the same home loan for the term of your natural life. You have the option of shopping around and switching to a better deal.
You might consider switching or refinancing a home loan for all sorts of reasons. More competitive deals than your current home loan may now be available, or a change in your circumstances may mean you need a loan with different features and conditions. Selling a home to acquire a bigger one is another reason for refinancing a mortgage. Concern about interest rate increases and the desire to find a cheaper loan or the need to consolidate debts into a single loan are other valid reasons for refinancing.
Refinancers form a larger percentage of current home loan applications than first homebuyers or investors. If you are one of them, the good news is, in this soft market, bank and non-bank lenders are competing harder than ever for your business.
Alex Twigg, general manager of UBank believes increased competition and hassle-free refinancing are encouraging more people to question their existing arrangements. “More people are looking for ways to avoid fees and stretch their dollar further,” he says.
Depending on your circumstances, the size of the loan and the value of the property refinancing can be an excellent strategy… but it doesn’t always work. So before making the decision to refinance, consider all the costs involved as well as the benefits – see the cut-out calculation in this article.
Do a home loan health check
Start by reviewing your existing mortgage contract. Take a look at the current interest rate, fees and other costs. Then check out a few reputable mortgage comparison websites like www.yourmortgage.com.au to see what else is available in the market.
The interest rate is the most critical thing to look at. Even a small 1% reduction can cut the interest paid on a typical $300,000 loan by $3,000 a year. On a larger loan the numbers grow significantly. A 1% rate reduction on an $800,000 loan would save you around $8,000 in interest repayments each year.
Based on a comparison of current home loan rates on offer at the time of writing, if you’re paying over 7% there’s almost certainly a better deal out there.
But the interest rate won’t be your only consideration. When looking for a better option, consider how important to you the following attributes of a mortgage are:
• Interest rate charged
• Flexibility of repayments
• Entry, exit and ongoing fees – or preferably lack of them
• Customer support and service
• Term of the loan – how quickly do you want to repay?
• Lenders mortgage insurance – is it required?
• Extras: does the mortgage provide an offset account, a redraw facility, etc.?
• Security against rate rises
Compare how your current deal rates for each of the above with other available loans on each of the above criteria. If alternative loans come out in front there’s a valid reason to refinance – but you still need to crunch the numbers carefully.
Refinancing means repeating the whole home loan application process, so it’s worthwhile making sure your credit record is in the best possible shape before getting started. To do this, pay off as much personal debt as possible and reduce credit card limits to manageable levels before starting the application process.
It’s important to demonstrate employment consistency so hold off making any career or employment change until the refinance deal is approved.
Once you’ve applied, ask the lender for a copy of their preliminary credit assessment so you can get an early indication of the status of your application and guidance about necessary steps to qualify for the loan.
Talk to your current lender
An existing lender may be prepared to offer a better deal in order to hold on to a customer so they are the best place to start when shopping around. Some of the bigger lenders have whole departments dedicated to keeping customers.
Sticking with your current lender is one way to avoid the costs of discharging the old loan and setting up a new one. Some lenders will still expect customers to go through the application process if changing from one loan product to another, but you might get some flexibility on the fees for doing this.
If you use a mortgage broker, the first thing they will do is attempt to get a better deal from your current lender. Brokers often have hundreds of customers with each lender so they can sometimes push harder to get a better deal for you. Also be sure to ask your lender or broker to waive as many fees as they can for you.
Work out the overall cost
Break costs (or exit fees) can be the biggest expense associated with refinancing, and the establishment costs for a new mortgage can also be substantial. These two combined can actually be greater than the interest you potentially save by switching home loans (even if the new interest rate looks like a great deal). So it’s well worth crunching the numbers.
As of 1 July, 2011 new government regulations required all new home loan contracts to be free of exit fees. Unfortunately, exit fees on existing loan contracts may still apply.
The other big cost of refinancing can be Lenders’ Mortgage Insurance (LMI). Most lenders will require you to take out LMI if you want to borrow more than 80% of your property’s value, and the cost of it can be significant.
LMI for a modest $300,000 loan if you have an LVR of more than 80% would cost around $4,300 (the exact amount varies by state and provider). Although this might not sound like much as a one-off payment, it starts to add up for bigger loans. LMI will be charged upfront and can either be paid as a lump sum or more often added to the balance owing on your home loan (a process called capitalisation).