Refinance is a most popular buzz word among the borrowers particularly for those hold mortgages. The reason of refinancing may vary from borrower to borrower. However, majority aim is to trim down the interest rate.
At this period of historic low cash rate set by RBA, many lenders are coming up with enchanting home loan products. So, refinancing your mortgage may favourable. However, it requires a precise comparison between your existing loan and the offered.
Following factors will help before you decide to refinance your home loan:
The objective of Refinance:
Without any objective, nothing can do well. So is refinance. Sort out your objective of refinancing. A number of reasons to refinance your home loan is –
– A better interest rate – mostly looking for a lower rate compare to the existing one
– Switching the type of interest rate – may be from variable to fixed
– Accessing the home equity – over the period of time, the value of the property changes and builds equity. Using the existing equity to make improvements in your property and therefore increase its base value is a smart move. Also to buy a new car or finance your holiday.
– Consolidating your existing loan – adding the personal loans or car loans into the mortgage to offset the extra repayments
– Adding additional home loan features – offset, redraws, split etc to take more value out of your mortgage.
One of the major tasks is to understand the current market dynamics. Whatever is your reason for refinancing, a proper knowledge of the market and the economy will pay you more. For instance, the economy is going through the boom phase. It means a rise in GDP, productivity, income, employment etc. Generally, the interest rate is higher in a booming economy. However, when the boom ends, it typically signals the start of a recession. So during the recession, the opposite is true. Property market and the credit market are highly affected by this cycle. So, before you refinance your mortgage, dig down in the available economy and property report. It will help to understand the current dynamic and forecast the future trend.
Types of refinancing
Refinance can be done in two ways. One is internal home loan refinance and the other one is external. The internal refinance allows you to refinance and continue your home loan with the existing lender. While the external refinance involves in moving to a new lender. The new lender will settle your remaining balance amount with your existing lender. It will re-write the home loan at the new agreed terms and conditions.
Whether to do internal or external refinance merely depends on various factors. It directly linked to your purpose or objective of refinancing. Mostly borrowers switch lenders if they can get a better deal on their mortgage. Or the existing lender may not be able to solve the unique circumstances. Like, you want to consolidate more than four types of personal loans while your existing lender allows up to three personal loans. In that case, an external refinance is helpful and may serve your purpose.
Interest rate Vs Comparison rate
The common reason to refinance is to find a new and low-interest rate. But a lower interest rate may not mean lower repayments. You may pay more after refinancing as off to adding more fees. Thereby, look at the comparison rate. The comparison rate gives a fair idea of how much your monthly repayment will be.
Fixed or Variable interest rate
Many often opt for refinancing their home loan to secure a fixed rate. A fixed rate is typically for a specific period of time. While Standard Variable Rate (SVR) floats and changes based on the cash rate.
If your current home loan balance is $475,000 for example at a variable rate of 5.11%, you are paying a monthly repayment of $2,807.33 for the period term of 25 years. You have also predicted that the interest rate will rise further in near future. Therefore, fixing the interest rate may reduce the risk of interest rate volatility and save your thousands of dollars over the life of the loan.
Pay attention to the economic changes before switching your home loan interest structure. Consider taking help from professional to avoid any mishaps.
Associated Fees with Refinance
One of the major points to consider before refinancing your home loan. There could be several fees associated with refinancing. Depending on the lender policy, different fees may be applicable. For instances, breaking a fixed term loan has higher cost implications and charges. You may pay more fees than saving from lowering the interest rate. So work out the fees and find out the exact dollar figures. A smart way is to check your current home loan agreement and find out the relevant fees.
If you are refinancing with a new lender, then check the figures first. Calculate the fees linked with the early settlement and discharge from the old agreement. It may be a worthwhile to chat with your current lender first and negotiate the existing loan terms.
If you are looking to access your equity then watch out the LVR. All the lenders have a set LVR. An LVR of above 80% comes at an additional cost of LMI.
There are other types of fees come with refinances. Find more here: How Much Does Home Loan Refinance Cost?
Paying less interest is achievable in two ways. One is the lower interest rate and another is the lower loan term. By lowering the interest rate, you may lower the monthly repayments. But it is likely to increase the total cost of your home loan. With a lower loan term, you may pay more in monthly repayments. But you are also paying off your loan faster and paying less interest.
If you have a reasonable and steady cash flow, consider a lower loan term (e.g less than 30 years) to quickly get rid of the loan. However, the financial reality may not remain constant all time. Refinancing in a lower interest rate is a good idea to solve the cash-flow issue in short term. If your cash-flow or income improves, add as much as possible in loan repayments. Consider having extra repayments feature or prepayment in your home loan agreement to implement this strategy.
Capacity to Repay
Now let’s look at the fact and figures. One key factor that influences the lender is the capacity of the borrower’s to repay.
Say for example you have entered into a home loan two years ago. You used to be a salaried employee with an annual income of $350K+. Assumed the remaining total balance of your mortgage is $2.5 million. In these two years, if you have changed your profession or business structure and became a self-employed. Assume your business is growing steadily but your annual income is down to less than $150K. Keeping this scenario if you want to refinance your existing loans with a new lender you need to pass the lender’s serviceability. Despite good credit behavior a new lender may refuse to consider your refinance loan based on serviceability failing criterion.
So it curtails to do the math before you apply for refinancing your home loan. Fortunately, the credit policy varies from lender to lender. Do some pre-work and it will be worth considering some professional advice or help. You can also try out online calculators to find your borrowing capacity. It is helpful to get some rough idea.
Research and try to compare
When looking for refinancing, nothing bids a good research. Lenders usually come with new offers when the cash rate changes. So it’s worth doing some pre-work. Many often prefer to go with one specific lender straight away. Even in this case, research may help to negotiate further.
If you are seeking lower interest rate, compare the market offer first. Then try to negotiate the same with your current lenders. If the lender agrees then you can save few dollars in fees and charges. Otherwise, try out with the next lender. If you want to access your home equity, try to look for lenders allow higher LVR.
Taking Help from a Professional
In many cases, refinancing the home loan is pretty simple. But it requires a good understanding of economic factors, market conditions and most importantly your financials. Often reasons of refinancing such as accessing the home equity, debt consolidation or even switching the type of interest rate may require a thorough analysis and calculations. Any miscalculation may cost you higher than your present loan. Remember, it is you who will be continuing with the home loan and the cost implications associated with it. So taking help from expert professionals does count.
After everything else, it is wise to consider some other factors where a refinance may not make sense. Such factors are, holding the property for not long enough, high penalties on refinancing especially breaking a fixed term, any previous impaired credit history, lack of a sound source of income etc.
Therefore, we suggest analysing your present circumstances followed by reviewing your home loan agreement before applying for refinancing.
You can also take help from us. Contact us to get a free home loan health check and make an informed decision.