If this is the situation you find yourself in, should you consider refinancing your existing home loan to one offering lower rates on new loan applications?
Well, yes and no.
There are lots of reasons people look to refinance … interest rate savings are often the most common, but people also look to refinance if they’re not getting the service they want from their lender, or if they want to find a loan with more features to help with saving or making additional repayments. In all of these circumstances looking to refinance is a valid idea, but it needs to be done with a high degree of caution.
Let’s look at interest rate savings. It may well be that you can avoid the cost of refinancing and achieve just as good a rate by converting your existing variable rate loan to a low fixed rate. While this won’t suit, if you are planning to sell your property in the short term, if it is your intention to stay put for a while then fixed rates are currently at all-time lows and will give you interest rate savings and greater certainty going forward. If you have no plans to sell then converting to a fixed rate is likely to be the cheapest and most effective option for you.
Should converting to a fixed rate not appeal then before anything, do your research. Look carefully at the costs involved in refinancing your loan. A good mortgage broker will not only alert you to the costs which relate to the new lender, but also the costs associated with leaving your current lender.
While the government banned early exit fees on variable rate loans for new loans entered into from 1st July 2011, there are many borrowers with home loans entered into prior to this date for which such early exit fees may still apply. It is important to be aware of these fees as they represent refinancing costs that you might incur when exiting your existing home loan, especially if it is less than five years since you took out your existing loan.
If early exit fees would apply to you, you need to make sure that the interest rate savings between your existing home loan and your new loan are enough for you to at least recoup these costs in the short term, otherwise the refinancing won’t be worth your while.
Exit costs on a home loan refinance will also vary greatly depending on whether you are in a variable or fixed rate loan.
If you are in a fixed rate home loan then you may also incur “fixed rate break costs”. Such break costs may apply if current fixed rates for new loans are lower than your existing fixed rate. If this is the case, then the lender will calculate the break cost and advise you of this amount. As a general rule of thumb, such break costs are broadly equivalent to the difference between your existing fixed rate and current fixed rates for new loans (for a term equal to your remaining fixed rate period), multiplied by your current loan balance.
Many fixed rate borrowers make the mistake of starting the refinance process, not realising that their fixed rate break costs are significant because of the dramatic interest rate reductions we have experienced in Australia during the past 12 months or so.
Something else to consider is your loan-to-value ratio. This concerns the amount of equity in your home and the market value of your home. If the balance of your loan is around 80% of the property’s value, it is possible that your new lender could value the home more conservatively and you would be required to pay lenders’ mortgage insurance. If this is the case, the cost of the insurance would impact any financial gains you think your might get by taking a new loan with a lower interest rate. If your LVR is less than 80% this is not necessarily going to be a concern.
Lastly, think about the features of your loan. If you are attracted to the idea of refinancing simply because there’s a low interest rate loan on offer, you need to look seriously at the conditions of the loan. Often low-rate loans are not as flexible or as well-featured as other loans which might have slightly higher interest rates e.g. an offset account may not be available.
Too often borrowers are ill-advised, or embark on a home loan refinance before doing the sums. As a result, the interest saving they think the home loan refinance will deliver is wiped out by the costs of the exercise. Don’t let this be you… read the fine print of your loan contract and check all your costs first – for both the outgoing and in-coming lender before you proceed down the path of refinancing your home loan. It must be a viable proposition to make the mortgage refinance option a worthwhile exercise.
And if you need help, just ask us