Nell Matzen - 11 Aug, 2021

How much lower of an interest rate makes it worth refinancing?

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Refinancing seems to be the buzzword of 2020/21, with a record number of Australian mortgage holders refinancing during the period. Droves of households are taking advantage of record-low interest rates, which were implemented to boost the economy after the financial impacts of COVID19. Even with interest rates inching up, they remain at historic lows and are tipped to do so until the Reserve Bank of Australia raises the official cash rate.

The major downside of refinancing is the potential costs, usually sitting anywhere between 2-5% of the loan amount. Refinancing also means you’ll be starting a new loan term, so you’re locked into the loan for another 15-30 years. Before you consider refinancing, the pros, cons, fees and savings should be weighed up to ensure it’s a lucrative decision.

When should I refinance?

Refinancing is taking out a new, better loan, to replace an existing one. It’s usually done to obtain a lower interest rate and save on mortgage repayments, but there are other instances where refinancing is utilised.

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Tap into equity

Refinancing can be used to tap into the equity in your home. Whether in an emergency or to pay for a new car, holiday or, most commonly, renovations – refinancing is a great way to access extra funds.

Refinancing can be used to tap into the equity in your home.

Changed from fixed-rate to variable-rate or vice versus

Refinancing can also be used to switch to a different type of interest payment – whether that’s a fixed or variable rate. Depending on whether your current interest type is serving you well or if there are better deals on offer with a different interest rate, refinancing may be right for you.

Shortening your loan term

For those who want to pay less interest or just pay out their mortgage as fast as possible, refinancing to a shorter loan term could potentially be a good option. Before choosing this path, make sure you can service higher repayments and still meet your other financial obligations.

Increase flexibility and features

When you initially applied for a mortgage, you were probably in a different financial position and on the hunt for the lowest interest rate possible. However, that most likely meant you had to sacrifice loan features and the flexibility that comes with loans with higher rates. If you find yourself in a better financial position with different goals, refinancing to access better loan features could potentially be a smart move. These features include offset accounts, withdraw facilities and extra repayments – which could help you meet your financial goals faster, including paying off your mortgage.

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To consolidate debts

Refinancing is a clever way to save on interest rates across all of your loans. For someone with multiple types of loans – personal, car loans etc., you can choose to refinance to consolidate all of your loans under your mortgage. Mortgage interest rates are usually considerably lower than other types of loans, meaning you can potentially save money on interest payments.

A lower interest rate

The number one reason mortgage holders choose to refinance is to find a lower interest rate – especially with interest rates at all-time lows. A lower interest rate could potentially save you money on interest repayments or help you pay off your loan faster. However, with all the costs involved in refinancing, crunching the numbers is essential to understand what interest rate is worth refinancing for.

Is 1% worth refinancing?

Refinancing to a 1% lower rate is, more often than not, a sound financial decision. A one 1% rate drop will give you big enough savings to justify the costs of refinancing. The savings you make can free up funds for household bills, fun or other investments. Or they can be directed back into your mortgage to pay it off faster.

Example: $250,000 loan

Refinancing to a 2.75% interest rate loan from 3.75% could save you roughly $250 a month on repayments – nearly a 20% reduction. With a refinancing cost of $5000, it would take just 20 months to break even on those costs.

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Is 0.05% worth refinancing?

A less than 1% reduction of an interest rate is only worth it if you plan on keeping your loan long enough to break even or if you can get the lender to cover the closing costs.

Example: $300,000 loan

Refinancing to a 3.25% interest rate loan from 3.75% could save you roughly $150 a month on repayments. However, with a refinancing cost of $6000, it would take 40 months, or twice as long as the 1% reduction example, to break even.

Is 0.25% worth refinancing?

Most experts agree that it isn’t worth refinancing unless you can secure an interest rate reduction between 0.5% and 1%. This may be a good general rule, but a 0.25% rate reduction might be worth it in some instances. If you’re refinancing from a variable rate to a 0.25% lower fixed rate, refinancing could be the right move, especially if rates are expected to rise in the near future. A 0.25% rate drop can also mean substantial savings for those with larger loans.

Example: $500,000 loan

Refinancing to a 4.25% interest rate loan from 4.5% could save you roughly $324 a month on repayments, or $19,000 over five years. Like a 0.5% rate, a 0.25% rate would be more financially beneficial if the lender covered the refinancing costs.

Most experts agree that it isn’t worth refinancing unless you can secure an interest rate reduction between 0.5% and 1%.

No closing-cost refinancing

No closing-cost refinancing is where your lender covers part or all of the refinancing costs for you and usually requires some negotiations. For example, if your current interest rate is 4% and the lender offers you an ultra-low reduction of 2.75%, you can use this as a bargaining chip. The lender may agree to pay your refinancing costs if you are happy to accept a higher rate. Although using this tactic will result in smaller monthly savings on your repayments, it eliminates the break-even point so you can start making genuine savings from day one.

When is refinancing not worth it?

There are some instances where refinancing is not worth it.

The new interest rate isn’t low enough – increasing your total interest paid

A lower interest rate isn’t a silver bullet for savings. If the interest rate you’re refinancing to isn’t low enough, you could end up paying more interest over the life of your loan when you consider your new loan term and the additional interest payments. Refinancing may still be the right choice if you’re looking for immediate savings instead of long-term ones, e.g., if your significant other is suddenly unable to work and contribute to the repayments. In this situation, negotiating a no closing-cost refinance could get you the best of both worlds. However, most mortgage holders won’t keep their new loan for the full 30 years. If a mortgage holder kept their loan for ten years as opposed to 30, they could still reap the benefits of refinancing, even if the difference in interest rate is slight.

You don’t have long left on your mortgage

If you and your mortgage have gone the distance, it doesn’t make sense to refinance and add another 30 years of interest. The only way refinancing is feasible in this situation is to refinance to a shorter loan term, which typically have lower rates. However, shorter loans have higher monthly repayments, so it’s not always the most affordable upfront option.

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Words by Nell Matzen

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