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What happens when you refinance your home loan?

Home Loan Refinancing is when a borrower either switches their home loan product with a different one that usually has a lower rate under their existing or a new lender. It means changing your existing loan for a new one and in most cases, with a new bank. The two main reasons people look to refinance their home loans are either to get a better rate or to increase their existing loan to withdraw some home equity.

You can refinance your home loan from any bank or lender you choose, and it doesn’t necessarily need to be your existing lender. These days, banks do not reward loyalty, and in most cases we find lenders offer better deals to new customers rather than rewarding their existing ones.

A refinance home loan refers to the home loan product borrowers switch to. Lenders sometimes offer a different set of home loans with their respective rates and features for refinancing applications.

There are two kinds of refinancing:

• External – When you switch your loan to a mortgage product provided by another lender.
• Internal – When you switch your loan to a mortgage product provided by the existing lender.

When your home loan is left unchecked for quite some time, it can pale in comparison to the newer loan products being offered to new applicants. This makes it ideal for you to review your loans regularly and see if refinancing is necessary to ensure that your mortgage is still as competitive as the ones in the current market.

What are the common types of refinancing?

As mentioned earlier, refinancing involves switching to another loan product offered by your current lender or jumping to a new lender with a new product and loan terms. However, there are several types of refinancing based on transactions with lenders. Here are some of the most common type of refinancing:

Benefits and why Should You Refinance Your Current Home Loan?

What are some reasons for refinancing? It is going to come down to your personal situation, and your own short to medium term goals. While people have a variety of reasons, here are the most common ones we see:

1. I want to reduce my home loan repayments

If interest rates have changed since you got your original home loan, which is a likely scenario at the moment, you may be able to refinance to a new loan with a lower rate. By refinancing your loan you can also reduce the amount of interest you pay. Reducing monthly repayments ultimately means you will pay less over the life of your loan.

If you have had your loan for more than 12 months, then you may be on an uncompetitive interest rate.

Let’s say your current home loan interest rate is around 4.50%, you owe $500,000 on your mortgage and current repayment is $2,533 per month. You could look at refinancing your home loan to a cheaper lender who can offer an interest rate of 3.75%, your monthly repayments would reduce down to $2,316 per month, reducing your repayment by $217.

Mortgage Reypament Comparison Table (30-year loan term)

The craziest part is the power of compounding interest.

Using the Your Mortgage Repayment Calculator to do the numbers, if you were to switch to the new lender with an interest rate of 0.75% lower, on your mortgage of $500,000 you would not only save $217 per month but you would save $78,426 over the life of the loan!

2. My property has increased in value

Broadly speaking, property prices in Australia have historically increased o. If your property’s value has gotten a boost, you might be able to refinance and get a better rate. These days, banks give better interest rates to borrowers with more equity.

For example, if you bought your home for $500,000 and had a loan of $450,000 but the property’s value has since increased to $600,000. In this case, your home equity has increased from 10% to 25% and lenders will be more willing to give you larger discounts in order to win your business. Overall, reducing your interest costs and helping you pay off your loan faster!

3. I want to modify the length of the loan period

Another reason behind many refinancing applications is to change the loan period. Depending on your situation, you might feel the need to shorten or lengthen your amortization period. In doing so, you can either pay more monthly but finish paying the home loan quickly or have lower regular repayments but for a longer loan period.

When you shorten your loan period, you must brace yourself for higher repayments. On the upside, you will be able to save a lot in interest charges in the long run. On the other hand, spreading out your loan for a few more years will help ease the financial burden. This, however, will result in you paying more interest over time.

Take note that Lenders and Bank may have different conditions on allowing your Home Loan Refinancing, read this post: How Long Before You Can Refinance?

4. I want to switch mortgage terms

If you currently have a variable home loan and you want to be able to secure your interest rate, you will need to refinance to a fixed-rate mortgage. You will be able to lock in your interest rate for a period of up to five years. This way, your mortgage rate will remain unaffected even with a potential rise in the official cash rate.

Refinancing to a variable rate might be tricky — if you are currently in the middle of a fixed term and you decided to switch to a variable rate, you might end up paying the break costs.

5. Access home equity

As time passes and as you pay off your home loan, you are also building up your equity in your home. This means that the proportion of the total value of your home that you actually own increases.

Many borrowers take advantage of their equity by refinancing. If the housing market is on the upside, there is a huge likelihood that their properties have appreciated as well. Refinancing will allow you to take a portion of your built-up equity and use it to fund any big purchase, such as an investment property, a new car, or a renovation.

When considering releasing equity through refinancing, your property will need to be reevaluated. The new valuation will help your lender determine your loan-to-value ratio and how much you may be able to borrow.

One important thing to remember is to ensure that as much as possible, your equity is more than 20% of your property’s value. This way, you will not be subject to paying for Lenders Mortgage Insurance. Besides, having little equity on your property will make it harder for you to refinance.

If you need a guide on Home Equity Loans in Australia, read this post: A Guide to Home Equity Loans in Australia

6. I want to consolidate other loans (and credit cards)

Lastly, you can refinance to consolidate other loans and debts into a single and possibly more affordable payment. This can be handy in situations where you have high-interest rate loans and debts like credit cards, personal loans or car loans. A debt consolidation refinance works in a similar way to a cash-out refinance, where an increased portion of the loan can be used to pay out other loans and debts. Your old home loan will be replaced by a new one that includes the amount you used to pay out those other debts.

Debt consolidation works well if you have lots of different credit cards and are paying very high-interest rates. The only downside when consolidating debts is to consider the new loan term and what the total interest costs will be after you have consolidated everything.

Read this post for more details: Is Debt Consolidation a Good Idea?

7. I want to do some renovations

After you’ve been in your home for a few years you might feel its time to do some renovations. These generally fall under two categories: simple renovations, like adding air-conditioning, solar panels or painting and structural renovations, like adding an extra level to the house, a pool or new kitchen.

If you are doing a simple renovation, the numbers work exactly the same as taking cash out and you would rely on the equity in your home. With structural renovations, you can rely on the on completion value of the renovated property. So for example, if you are adding an extra bedroom and bathroom to the property, which would increase the value of the home by an additional $100,000 - the bank can lend on this figure.

Using the example above, if by adding an extra bathroom and bedroom increased the property’s value from $600,000 to $700,000 you could then increase the lending to $560,000 meaning additional lending of $110,000 can go towards your renovations.

8. I want to increase my loan and take cash out

A cash-out refinance allows you to use the equity you have in your home to borrow money at a lower cost. You may want to invest these funds into shares or use it as a deposit towards a new investment property.

How exactly does increasing your loan work?

Using the example above, let’s say your house is today worth $600,000 and you have $450,000 left on your current mortgage. This means you have $150,000 in home equity. You could refinance to turn $30,000 of this equity into a home loan, bringing your total lending to $480,000.

You can potentially increase your loan above an 80% LVR (loan to value ratio) but you would need to pay for lenders mortgage insurance so it would be best to talk to your mortgage broker and understand what these numbers look like because the costs of Lenders Mortgage Insurance could range into the thousands.

9. I can afford to pay more off my loan

For some people, changing the length of your loan term can help pay off your loan quicker. If you can afford higher monthly home loan payments, you could refinance to a shorter loan term. In this case, you could look at reducing your loan term from 30 years, to 25 years helping you pay your home loan off faster, saving you literally tens of thousands of dollars in interest payments over the life of the loan.

The costs associated with refinancing

Refinancing is not free, especially if you are shifting to another loan provider. Before anything else, you must check the upfront costs you have to settle before you transition to a new lender.

The costs of refinancing may include:

• exit costs and deferred establishment fees (sometimes quite hefty)
• new establishment/application fees
• loan approval fees
• settlement and handling fees
• additional mortgage stamp duty
• additional lenders mortgage insurance if your equity is below 20%
• mortgage registration
• account fees on a new loan

Read: How much does it cost to refinance your home loan?

As a golden rule, borrowers should only really consider refinancing if they can recoup these costs within 12 months. It’s better not to refinance when the exit and entry costs outweigh the benefits in the short to medium term - this is likely to be the case with fixed rates. In most fixed-rate cases it would be better to ride out the fixed-rate term due to high exit costs.

In terms of interest rates, it’s usually only worthwhile to refinance if you can get at least 0.75–0.80% off your current rate.

If you're in doubt, don't hesitate to consult a lending specialist as they can help you assess your current financial situation and determine exactly what you can afford with your budget. Ultimately, the goal of refinancing is to ease your financial burden and to save money in the long term.

Once you refinance to a more suitable mortgage product you need to make sure you reassess the health of your home loan every few years in order to make it work hard for you.

Also read: Refinancing myths and reality checks

How to Refinance a Home Loan?

To start your refinancing plans, you need to first review your current home loan, its interest rate, and its features. You will have to compare your current mortgage against the new ones currently being offered in the market.

Before considering jumping to a new lender, ask your current lender first what options they could give you. Examine how much it would take to refinance according to your purpose.

You can speak to a mortgage broker to widen the scope of your options. A mortgage broker can help determine which lenders and loan products suit your current financial needs.

Once you have decided on the best option, prepare all the needed paperwork, submit your application and documentary requirements, and wait for approval.

If you are switching lenders, inform your current lender that you are refinancing. Your new and current lender will take care of the process after you get approval — you only need to prepare your wallets for the fees.

For a more detailed view, check out YourMortgage's guide to Home Loan Refinancing: A Step By Step Guide To Home Loan Refinancing