Refinancing your current home loans can be a difficult choice. Just because you see a better rate is available, it doesn’t necessarily mean you’ll end up saving money by switching. However, if you do it right, and at the right time, you could end up saving large sums!
Unsatisfied with your rates or seeking better customer service? You’re certainly not alone. There are always plenty of borrowers looking for a better deal.
But while it might look like a good idea on a quick glance, refinancing has its hazards and needs to be considered carefully before going forward.
Despite the smaller number of players and number of mortgage products in the mortgage market, competition is still alive in Australia, as shown by the results of this year’s Mortgage of the Year Awards.
The latest data from mortgage broking company AFG also showed the proportion of homeowners refinancing their mortgages hitting an all-time high, driven by the recent interest rate increases.
While refinancing is a necessary tool for borrowers who have been hit hard by the recent rate hikes, it is currently not as easy as it once was, as banks are holding their dwindling funds close to their chests.
What to First Consider
When refinancing CAN make sense
- Your lender’s rate isn’t staying competitive with others in the market
- A major change occurs in your financial situation
- You are looking for more money to pay for home renovations, a child’s education costs, or invest in another property
- Switching to a fixed rate at an opportune time
- You’ve started to see large credit card debts and want to consolidate
When it might NOT make sense
- You might not own the property for much longer
- Prepayment penalties are high on exiting home loan
- Since your previous loan your credit history has taken a hit due to outstanding debts, making it less likely you’ll get a good rate
- You’ve got an uncertain income over the period of the loan, such as work as a freelancer
- Your loan balance is low and you’re not thinking of redrawing on available equity
Before refinancing, a borrower should consider their circumstances over the next three years. You should ask yourself whether flexibility, a lower rate, lower fees or debt consolidation is the goal.
Just chasing a lower interest rate won’t be enough. You need to think about the entire life of the loan, not just the headline interest rate. Also think about the costs of changing to another lender.
Some of the most important things for borrowers to be aware of when considering refinancing include the impact of any fees that may be applied, such as entry, exit, application, valuation, stamp duty and legal fees, as well as any other ongoing charges.
Is It the Right Time?
It is also wise to consider the term of the loan – as this can significantly impact long-term financial obligations, as can whether a fixed or variable interest rate is selected.
Another factor is the security of your income. While Australia has so far weathered the global slowdown, there are still plenty of risks on the global stage that will undoubtedly impact upon Australian lenders and borrowers.
Therefore, you need to consider how secure your job is or if you can manage the home loan on one wage instead of two. And borrowers should also be aware of the early warning signs that refinancing with a particular lender might not work out.
If something doesn’t feel right early on, it might be time to look further. For example, if a lender is slow in approving your loan or doesn’t communicate well during this period when they are trying to win your business, you need to think if their service will improve once they’ve got your business.
It’s also worth talking to your existing lender when considering refinancing with another one. Some lenders might go to unexpected extreme lengths to keep you, such as waiving fees, rather than let you go to a competitor. That can be especially true if you’ve made all your payments on time and have been with that lender for a number of years already.
If you approach another lender, it’s important to always present the best financial picture of yourself to them. Make sure you’ve paid off as much of your other debts as possible and drop unnecessary credit cards.
Those who want to refinance but have been late in paying their bills and owe considerable amounts on a credit card might not be able to find a lender who is going to offer very good rates.
When it Makes Sense
There can be many reasons to refinance – a job change influencing your financial situation, a current lender’s loan rate that isn’t keeping pace with the competitors, or you want to obtain even more real estate or perhaps need to renovate what you already have.
Even if there isn’t any specific reason you have in mind, it’s always worth weighing up the viability of refinancing from time to time. Over the years loan products have improved: there might be a much better deal out there.
Around every three years is a good time to fully reassess one’s loan and compare it to other products that are in the market. By doing this, you can determine if a change will provide you with the flexibility you may now require, or if the fees and charges are high compared to other products.
This timeframe allows you to manage your interest rate risk and avoid costly break fees.
If you have locked in all or some of your loan over a three-year period, it would be a good idea to start looking at least a few months prior to its expiry. Finishing off the three-year period will also ensure you minimise the ‘get out fee’ charged by most banks.
Wanting a lower interest rate and lower repayments is one of the more common reasons to refinance. Many borrowers have been frustrated that their lender increased their interest rate by more than what was set by the Reserve Bank of Australia, while other lenders have only passed on the set increase or even less.
Even a slight increase (or decrease) in your interest rate can make a major difference over a long-term loan. Others who are looking to refinance might just want to fix their repayment, especially if they sense rates have – or soon – will bottom out.
As is the case recently, there has been a flurry of fixed rate cuts by the major lenders. While rates are expected to rise further into 2010, they will eventually stop rising and go back down again. That’s the best time to fix your loan, but it’s not that easy to predict.
Another reason to refinance your home loan might be to consolidate your debts and only have one monthly repayment. If you have multiple debts from various sources or institutions such as a home loan, personal loan, credit card or other high interest loans, and you’re having trouble paying these off, then it could make sense to roll these debts together with your home loan. The main advantage here is that your home loan rate is typically a lower rate.
Some credit cards have rates as high as 20% or more, which is more than double what you’d find with a home loan rate. The key is to make sure you don’t lower your repayments once you’ve consolidated. The same is true if you manage to get lower interest rates on your variable home loan. The savings that this provides should be used to pay the loan off faster, so don’t be tempted to use this as spending cash.
Some borrowers also want to refinance to use the equity in their home to pay for home improvements or other reasons. Keep in mind, while allowing you to expand your property portfolio or value, it will also greatly increase the loan term.
Also make sure when you refinance that you will be in a home you’d like to stay in for a fairly long period of time.
Moving house shortly after refinancing could mean you might not be able to take advantage of the cost savings.
When it Doesn’t Make Sense
There are some situations where refinancing should be avoided if possible. You shouldn’t refinance while chasing slightly lower rates if you’ve built a good relationship with your original lender.
In these circumstances, chasing a small reduction in interest rates may prove a mistake. Like other industries, you can get what you pay for: going to a new lender for a small rate reduction may mean you are not looked after. If you miss an opportunity as a result of this, then this rate cut would have proved costly.
Also, consider how long into your loan you are. If you’ve been paying your loan for 20 years already, refinancing to a longer loan term will reduce your payments in the short term, but cost you many more years and thus more money.
Calculations must also be made in terms of prepayment penalties on some home loans. If you have a penalty on your existing loan, weigh that cost against any savings you would make. Refinancing is not for everyone. If the current rate on your loan is comparatively low, there is no benefit to be had from refinancing.
In fact, you may end up incurring more costs when exit and other administration fees are taken into account.
If the current balance of your loan is already low and you do not intend to redraw on the available equity, then refinancing is usually not very beneficial.
Find the break-even point – the amount of savings on the rate necessary to make up for any penalty fees. Some exit fees from loans can be more than $1,000. That value might make the difference for some in determining whether or not they want to refinance.
Tax Considerations
Those considering refinancing should also consider how their taxes play into the equation, especially borrowers with an investment property.
Unless a loan for your investment property is borrowed against that property, you are unable to claim a deduction for any expenses that are incurred while the property is being rented out. With that in mind, it is important to always seek advice from your tax professional in order to maximise such deductions. You also always want to make sure you are operating under the rules of the Australian Taxation Office. Shop around, crunch the numbers, and make sure whatever you do makes financial sense over the long run.