For the first time refinancer, there can be many little traps throughout the refinancing process that can mean paying more than you expected.
All it takes to dodge these traps is being armed with the right information. This can be gained from talking to someone who has refinanced before, chatting to an impartial expert and reading as many resources about refinancing as you can online.
Trap: adding smaller debts to your loan
A common trap that people fall into when refinancing is to think that it’s a great way of rolling all their debts into one.
It’s easy to see why people fall into this trap. Bringing everything together can ease the pressure of having to pay off a small debt in a short time frame, and a home loan interest rate is often lower than that on other debts.
So, what’s the big deal?
The problem comes when smaller debts, like car loans and credit card debts, are stretched out over the total loan term. By adding them to your principal loan amount, and paying them off over 20 or 30 years, you are allowing more time for interest to accumulate and will end up paying significantly more.
How to avoid the trap of adding smaller debts
If you still want to roll your debts into your home loan, as a way of consolidating, that’s fine. It can be a good way of relieving immediate stress and financial pressure.
The way to avoid this becoming costly is to then impose your own timeline of paying off the extra debt. This means making extra repayments every month until you have “paid off” your additional debt amount.
This will help you avoid paying excessive interest on your smaller debts but, as it is enforced by you, you can skip a repayment every now and then if you need to. This puts the control of the debt back in your hands while still acknowledging the need for the debt to be paid off ASAP.
Trap: borrowing more for a home than you need
If you’ve had your home for a while, and the value of your property has grown over time, you may find that when you come to refinance you are able to borrow more than you expected.
This can seem like an exciting prospect as you are seeing the true value of your home presented to you as cold hard cash. But beware, it will not do you any favours in the long run to be repaying a loan that is bigger than necessary.
It is also not advisable to borrow more than 80 per cent of your property’s value when refinancing as you could be hit with a charge for Lender’s Mortgage Insurance.
How to avoid the trap of borrowing too much
Remind yourself why you decided to refinance in the first place.
If the answer was to save money or to pay off your loan sooner, then you will not be doing yourself any favours by taking out a larger loan.
If you did want to refinance to borrow more, make sure you know exactly how much you need before you go to your lender so that you are not tempted to go over the necessary amount.
Trap: falling for honeymoon rates
Lenders, in an attempt to make less competitive loans more attractive, will advertise an introduction deal or “honeymoon rate” deal. This usually involves borrowers receiving a discounted rate for a set time period before the loan reverts to the standard variable rate.
However, this rate is often much higher than not only the introductory rate but than the average rate on the market as well. The result is that the borrower, instead of saving money with the discounted rate, is sucked in to paying more over time.
How to avoid falling for honeymoon rates
The best way to avoid falling for this trap is to compare home loans by their comparison rate, not their advertised interest rate.
The comparison rate will take into account the total cost of having a certain loan, including fees and a potential revert rate. This gives you a more accurate indication of the true cost of a loan.
Trap: refinancing to a longer loan term
When people refinance, they often do not consider the implications that this could have on their overall loan term.
It's common that lenders will refinance your loan to a 30-year term when you may have already completed several years of your loan. What this does is reduce your immediate monthly repayment amount but increase the amount of interest that you pay in total by potentially tens of thousands of dollars.
How to avoid this trap
The easiest way to avoid this trap is to find out how long is left on your current loan before you refinance and then discuss with potential lenders up front how long you want your new loan to be.
If they refuse to let you refinance to a loan term of the same length it will be worth looking for a lender who will.
Trap: accepting upfront fees without negotiating
While some lenders charge some combination of set up fees, many will be willing to negotiate or waive these fees in order to earn your business. This is a cost that can end up being a couple of hundred dollars so if you do opt for a lender who charges upfront fees it is wise to not accepting them without a negotiation.
How to avoid the fee trap
In your initial contact with your potential lender, let them know that you’re interested in their product but aren’t willing to pay the upfront fees.
Do your research and find examples of similar loans that don’t charge upfront fees. You can use this as leverage to get your desired lender to lower or waive upfront fees.