Alan Hartstein
Athena Cocoves
As a first homeowner, you’ll undoubtedly want to pay off your mortgage as soon and as cheaply as possible, leaving you with a valuable asset that you own outright. Refinancing can be a valuable tool in helping you achieve this goal and has a number of notable benefits as long as you’ve built up sufficient equity in your property. Here’s when you should refinance a home loan and when you should be cautious.
When you should refinance a home loan
Refinancing a home loan means replacing your mortgage with another from your current or another lender. This option makes sense when you get a better deal and see favourable changes in terms, conditions and interest rates.
- Lower interest rate
- Reduced fees and charges
- Lower monthly repayments
- Avoiding a high-interest revert rate
- Cash incentives
- Extra features and facilities
Lower interest rate
A lower interest rate is an obvious starting point. That’s because the interest rate attached to your mortgage determines how much you pay over its term. So, even a small reduction can make a big difference over the long term. Just go to a mortgage calculator to see the difference.
Let’s say, for example, that you currently have a 30-year mortgage for $600,000. Your interest rate is at a variable rate of 6.24%. Five years later, that amount has reduced to $550,000, and you want to refinance.
Your monthly repayments are $3625 for a principal and interest loan. The total payable over the remainder of the mortgage term is $1,087,435. If you can refinance to a loan of just half a percentage point lower (to 5.74%), your monthly payment falls to $3457, saving you $168 a month. Meanwhile, the total repayment figure is reduced to $1,037,029, saving you over $50,000 over the life of the mortgage.
If that interest rate is reduced by one whole percentage point to 5.24%, that figure falls to $987,786, saving you nearly $100,000. Additionally, many lenders now offer rate reductions for new customers to entice them. So, you should be mindful of what’s on offer when researching. Remember that with a standard variable loan, the interest rate on your new mortgage could easily go back up to where you started or fall in line with market forces.
Reduced fees and charges
Many refinancing deals also tout reductions in fees and charges or waive them altogether. These can include establishment or application fees, ongoing monthly account-keeping fees or exit fees from your old lender that the new one will pay.
These are not to be scoffed at and will obviously save you money both in the short and long term. However, reducing your interest rate will be far more beneficial in the long run.
Once again, running some numbers through a mortgage calculator will bear this out. For example, say you’re currently paying off a $400,000 mortgage with the same standard rate of 6.24% with annual fees of $120. One refinancing option involves the removal of those fees. That’ll save $10 a month and $3000 over the life of the 25-year loan ($793,862 compared with $790,862). Any savings is a benefit, sure. Still, the benefit of not paying a fee is far less than you’d save with a lower interest rate.
Where possible, getting a refinancing deal that incorporates interest rates and fee reductions is better.
Lower monthly repayments
This ties into the above two benefits, where lower interest rates and fewer charges both contribute to lower minimum monthly repayments. Depending on your financial circumstances, this can be vital for freeing up much-needed cash for anything from renovations to buying a car or just giving you more leeway to pay for essential living items if you’re feeling the pinch financially.
Avoiding a high-interest revert rate
Mortgagees who are currently on a fixed-interest home loan will have taken it out with a fixed introductory rate for a maximum of five years. This rate is less than they would pay with a standard variable loan. However, once the loan reverts back to the variable, it is often at a higher rate than the average market offer.
For this reason, fixed-loan mortgage holders have a particularly good reason to refinance so they won’t face what could be a steep increase in their monthly repayments. Just be aware that refinancing a fixed-interest loan before the fixed term expires could come with high accompanying fees from your current lender.
Cash incentives
Competition for your refinance business is quite high, and some lenders offer cash bonuses or frequent flyer points to jump from your current lender.
For example, some banks have recently offered up to $3,000 cashback for refinancing with them. If you’re intrigued by offers like this, be sure to check the fine print.
Higher annual fees often accompany these offers. While a few thousand dollars cash in the hand may seem attractive at the time, it represents a tiny part of your entire mortgage equation and should be treated accordingly. At any rate, it’s still worth factoring into your refinance budget.
Extra features and facilities
Your new mortgage may offer features such as redraw and offset facilities that are not currently available in your current mortgage. However, like the cash incentives, these features shouldn’t play a big part in your overall decision because your current lender should be able to provide you with these on request, provided you have sufficient equity in your property.
» MORE: How to make the most of your offset account
When you should not refinance a home loan
Refinancing may seem like an obvious course of action that saves you time and money. However, there are pitfalls to be aware of and some situations where refinancing may not be in your best interests.
- Exit costs
- Your property falls in value
- The fees outweigh the benefits
- Refinancing means paying more
- You want to sell the property
- Your credit score is affected
Exit costs
If you have a fixed-rate mortgage, the costs of terminating the contract early could outweigh the benefits of refinancing, at least until the fixed rate expires. Once you revert back to a standard variable rate, it will usually be worth refinancing, especially as you are likely to be paying a higher rate than the market average as a trade-off for getting a lower fixed rate in the first place.
Your property falls in value
Just because you’ve had a mortgage for three or four years, there is no guarantee that your property will have risen in value. House prices in Australia fell by 9.1% overall in the period from May 2022 to February 2023, according to figures from CoreLogic, and many homeowners will have seen the equity in their properties fall in tandem.
Without 20% equity in your property, or when your loan-to-value ratio is above 80%, you may have to pay the dreaded lenders mortgage insurance. LMI could run into the tens of thousands of dollars and totally negate any potential refinancing gains.
Timing is everything, so until you gain or regain at least a 20% equity level in your property, refinancing makes little sense — unless your current or future lender is willing to give you serious insurance concessions.
The fees outweigh the benefits
The size of your mortgage may no longer justify the costs and fees associated with refinancing. That may be true even if you can obtain a lower interest rate of half a percentage point. At this point, switching lenders or even negotiating for a better deal with your current one may not make sense.
Refinancing means paying more
One potential hazard you need to be especially wary of is refinancing your loan for a longer term. This could result in you paying way more in total over the long run.
For example, say you have been paying off a 30-year mortgage for five years. You should aim to refinance it for the same term that is left on your current mortgage (25 years). Otherwise, if you refinance and your new lender reverts your mortgage automatically to a 30-year term, you’ll pay more interest in the long run. Most of your mortgage payments in the first few years go towards interest without seriously considering the principal.
Remember, the longer the mortgage, the more money it costs you. If the monthly savings are of more value to you now than the long-term savings, you may have the option to extend back to 30 years.
You want to sell the property
If you plan to sell your property at some stage over the next 12 months, or even the next couple of years, it might not be worth your while to refinance. The fees and rigmarole that are likely to be attached could negate any potential savings.
Your credit score is affected
Your credit rating or score could be adversely affected by chopping and changing loans frequently. However, this shouldn’t deter you from pressing ahead because maintaining regular payments will quickly bring you back to your previous rating.
About the Author
DIVE EVEN DEEPER
What To Know About Refinancing a Home Loan
Refinancing a home loan means replacing your mortgage with another from your current or another lender, ideally at a lower interest rate with better terms.
What Is a Redraw Facility?
A home loan redraw facility gives homeowners the flexibility to build wealth while reducing debt.
Should I Fix My Home Loan?
Knowing whether or not to fix your home loan for a set period of time or to take on the relative risk of a variable rate is one of the major challenges that will confront you as a first-time home buyer.
Understanding Your Mortgage Amortisation Schedule
A mortgage amortisation schedule shows how you’ll pay off your home loan over time, typically monthly for up to 30 years, and how much principal and interest you’ll pay.