With record-low interest rates, refinancing has become a popular choice in Australia with 8% of new home loans in 2020 being refinanced mortgages.
Not only are banks drawing in customers with cashback offers and competitive interest rates, but many savvy borrowers are also searching for increased flexibility with their home loan arrangements and more product features.
What is refinancing?
Refinancing means switching your home loan from your existing lender to a new one. For the new lender, it’s basically a new loan but because you’ve already bought the home there is no involvement from a vendor or settlement agent. You will, however, need to undertake a property valuation.
Many people opt to refinance to take advantage of obtaining a lower interest rate, access to special offers or flexible loan terms and features, reduced fees or simply for debt consolidation reasons.
You can refinance your home loan with your existing lender (an internal refinance) or with a different lender (an external refinance or loan transfer).
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What are the pros of refinancing?
There are many benefits to refinancing your home loan. Here are five advantages to consider:
1. Lower Interest Rates
With the RBA (Reserve Bank of Australia) introducing a record low cash rate of 0.25%, many banks and other lending institutions have passed the rate cut on to consumers with competitively priced home loan products.
By remaining loyal to your lender, you could be missing out on much better deals that could help you reduce the cost of your repayments each month, or pay off your mortgage faster by paying down the interest sooner if you keep your repayment amount the same.
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2. Refinance Rebates
For borrowers who meet the right criteria, there are lenders offering a refinance cashback of up to $4,000. To qualify, there are strict requirements surrounding the loan amount, your LVR (loan to value ratio) and other stipulations. Ensure you read the fine print thoroughly before taking any action.
3. Access to Your Equity
Refinancing your home loan gives you access to the equity you have accrued over the life of your home loan. You can use your equity for a variety of reasons, such as:
- Investing in a new property, or other investment options
- Purchasing a new car
- Going on a holiday
- Renovating your home, and more.
If your aim for refinancing is to get the most competitive interest rate possible, then it’s better to have more equity in your home, rather than use it on other items. It’s worth being clear on your financial goals when making your decision.
4. More Control Over Your Finances
Refinancing can give you greater flexibility to manage your finances. You may be able to opt for a shorter loan term to pay off your mortgage sooner with increased monthly repayments and lower interest, or you could increase the loan term to make your regular repayments more affordable each month, reducing financial stress.
You can also choose to consolidate your debts into just one monthly repayment that is more affordable with a lower interest rate than that which typically comes with a credit card or car loan.
5. New Loan Features
If your current home loan is a no-frills type of loan, upgrading to a loan that comes with features such as a redraw or offset account can help you pay your mortgage faster. You may be able to negotiate this with your current lender.
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What are the cons of refinancing?
Here are some of the cons of refinancing:
1. It Can Be Time-Consuming
Refinancing can be a slow process. For many borrowers, they may feel like all the work is not worth it. Discharging and transferring your loan to your new lending institution can chew up time, and the speed of the process usually depends on the lenders involved.
Typically, refinancing comes with a few different fees that can stack up to thousands of dollars. In some cases, it will be much lower, but you will need to check first with any potential lenders to weigh up the benefits of switching your loan. These include:
- Discharge fees
- Property valuation fees
- Application fees
3. Lenders Mortgage Insurance
Your new lender may require you to take out LMI when you switch your home loan if you have less than 20% equity in your home. This protects them if you default on your mortgage, but it could cost you a lot of money.
Related article: Understanding Lenders Mortgage Insurance (LMI)
4. Resetting the Loan Term
Refinancing resets your loan term. Say you have already paid off four years of a 25-year loan term, when you refinance your home loan with a new lender you’ll be paying off 29 years worth of interest instead.
How much would refinancing save you?
Refinancing has the potential to save you a significant amount of money and can shorten the term of your loan. The longer you have your loan with your existing lender without refinancing, the bigger the interest rate gap is between what you’re paying and what a new customer is paying.
According to the ACCC, borrowers who have been paying off their mortgage for three to five years are paying around 58 basis points more than those with new loans. By refinancing with a comparable rate to a new customer, the average borrower could save at least $17,000 in interest paid over the life of their loan.
Imagine how much more you could save with a 100 basis point reduction. You would be on the path to financial freedom and owning your own home much sooner.
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Do you need a deposit to refinance your home loan?
Generally, there is no deposit involved in refinancing your mortgage. However, you should be aware of the different fees you may be required to pay, along with any LMI that will be added if your LVR is more than 80%, or your equity is less than 20% of the value of the property.
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Does refinancing hurt your credit?
When you make any form of credit application this information goes directly onto your credit file. If this is the first time you’re refinancing, it shouldn’t have much of an effect, but if you tend to refinance your home loan frequently it could have a negative impact on your credit score and the interest rates lenders offer when refinancing again.
How much equity do you need to refinance your house?
At a bare minimum, you should have at least 5 per cent equity in your home. Most loans have an LVR maximum of 95%, so you can only borrow up to 95 per cent of the value. For better interest rate offers, most lenders like to see that you have built equity of about 20 per cent.
Related article: What is a home equity loan?
Is it expensive to refinance a mortgage?
There are costs involved in refinancing, but studies have shown that most borrowers can recoup their switching costs within four to six months if they get a good deal on a lower interest rate. Some lenders may even waive certain fees, so it pays to enquire.
Here are some of the costs to consider:
- Discharge fee for exiting your existing loan: $200 to $400
- Setup fees for new loan: $250 on average, but can be as high as $1,000
- Standard property valuation fee: $200 to $500.
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How do you know when to refinance your mortgage?
There are many reasons people want to refinance their home loans, with one of the top priorities being to save money with a lower interest rate.
Other reasons people choose to refinance are:
- Unhappy with the service from their current lender
- Want to consolidate debts
- Fixed rates are about to expire
- Looking for extra features their current home loan product doesn’t offer, such as an offset account or a redraw facility.
If the interest rate you’re paying is not reflecting the current market rates, or you want to refinance for any of the other reasons listed, it’s a good idea to speak with a trusted mortgage broker for professional home loan advice.
Words by Katy Holliday
Now that you know the costs of refinancing as well as the benefits, you can make an informed decision as to whether it’s the right choice for you. Whether you’re buying your first property or want to make the switch, eChoice’s mortgage brokers can help you compare hundreds of home loans to find a suitable option.