Home loan health check

One reason to conduct regular home loan health checks is because a seemingly small difference in mortgage rates can make a big difference over the term of a loan.

Some people don't refinance their mortgage because they don't compare mortgage rates and realise there are lower-rate options on the market.

Other people never get around to refinancing because they keep telling themselves, "There's no rush, I'm only paying a few dollars extra per month”.

However, a small reduction in monthly repayments can add up to a saving in total costs over the life of the loan.

For example, imagine you have 20 years left on your mortgage and you manage to refinance from a home loan with an interest rate of 4.50 per cent to one at 4.00 per cent. Here’s how much you could save based on an outstanding loan of $300,000, $500,000 or $700,000:

Hypothetical examples are for illustrative purposes only. Does not account for fees or interest rate changes over time. Source: MoneySmart

The cheapest loan isn't necessarily the best loan, but the interest rate is always an important factor when assessing the pros and cons of a mortgage.

By conducting a home loan health check, you can not only get an idea of how your home loan interest rate compares to the rest of the market, but you can also consider several alternative mortgage options.

Conducting a home loan health check shouldn't mean just comparing mortgage interest rates. It's also important to look at home loan fees.

Many home loans come with ongoing fees, which can include:

• monthly fees
• annual fees
• offset account fees 

Borrowers can also be slugged with fees for making use of some home loan features, like redrawing funds or making additional repayments.

Some lenders also get you on the way out by charging a discharge fee when you finally close the loan.

Fees can be a bit like interest rates in that paying a bit more in the short term can lead to a paying a lot more over the loan's full term. 

Imagine that you had 20 years left on your mortgage and you switched to a home loan with lower fees. Here’s how those savings can add up:

• $100 per year = $2,000 over 20 years
• $200 per year = $4,000 over 20 years
• $300 per year = $6,000 over 20 years
• $400 per year = $8,000 over 20 years
• $500 per year = $10,000 over 20 years

Still not convinced about the benefits of a home loan health check?

Does your home loan offer the kind of features and benefits that could make managing your finances quicker and easier? 

A few examples include:

• Extra repayments: Paying more than the minimum required amount onto your home loan can shrink your home loan principal, paying off your property faster and helping you save on interest charges. 
• Redraw facility: This flexible feature gives you the option to take any extra repayments you make onto your home loan back out of your mortgage again if you need the cash. 
• Offset account: A savings or transaction account linked to your home loan. Money saved in this account is used to “offset” your mortgage principal, so you can be charged less interest. For example, if you owe $300,000 on your mortgage, and have $20,000 saved in your offset account, you’ll be charged interest as if you only had $280,000 owing. 

Similarly, if you’re not getting a lot of use out of your current home loan’s features and benefits, refinancing to a more basic “no frills” home loan could mean enjoying a lower interest rate and/or cheaper fees. 

Once you've done a home loan health check and mortgage rate comparison, if you decide you do want to switch home loans, you'll have to refinance your mortgage.

How refinancing works: 

1. Imagine you have a mortgage with Lender X, with an interest rate of 4.50%, outstanding debt of $300,000, and a remaining loan term of 20 years.
2. After comparing more than 100 lenders, you decide you like the look of Lender Y, which is offering a similar home loan to Lender X, but with a mortgage interest rate of just 4.00%.
3. If you decide to refinance, Lender Y would repay your debt to Lender X – you would owe nothing to your old lender, and instead owe $300,000 to your new lender.

However, before you sign on any dotted lines, it’s important to ask yourself a few questions, such as:

Did you check the comparison rate?

When you make a home loan comparison as part of a home loan health check, it’s important to consider the 'comparison rate', and not just the 'advertised rate'.

A home loan’s advertised rate only indicates the cost of mortgage interest, and doesn't include fees or other charges. Sometimes a home loan with a low interest rate but high fees can actually cost more over the long term than a home loan with a higher interest rate and low or no fees. 

A home loan’s comparison rate combines its interest rate with the cost of its standard fees and charges, giving you a better idea of its total overall cost. This can provide a quick and simple way to compare home loans and provide a better idea of which offers may cost more over the long term.  

With some loans, there will be no gap between the advertised and comparison rates, while others will have a significant gap of one percentage point or more.

Will you need to pay fees? And what for?

If you do refinance, you may have to pay a range of fees to both lenders. 

Your old lender may slug you with a discharge fee, and if you're exiting a fixed-rate loan ahead of schedule, you will probably have to pay break costs as well.

Your new lender will probably charge you any combination of standard set-up fees – establishment fee, valuation fee and settlement costs. All these fees could easily add up to more than $1000.

Has your property’s value fallen?

If your property is located in an area where values have fallen in recent years, refinancing could potentially cost you more money than you expect.  

For example, imagine that when you bought the property it cost you $500,000 and you borrowed $400,000. That would have given you a loan-to-value ratio (LVR) of 80% and allowed you to avoid paying Lenders Mortgage Insurance (LMI), which is generally only charged if you have an LVR above 80%.

Now imagine that two years later, you've decided to refinance, having reduced your debt to $385,000 – but you’ve also seen the value of your property fall to $475,000.

When Lender Y values your property as part of the refinancing process, it will discover that your LVR is now 81% and charge you LMI, which could cost you thousands.

Are you refinancing into a longer home loan?

When you refinance, you may want to check if your new loan term matches your old one. The default loan term for many mortgages is 30 years, so if you're not careful, you could accidentally exit from a mortgage that has 20 years left to run with Lender X, and sign up for a new 30-year mortgage with Lender Y.

A longer loan term means you’ll be in debt and paying interest for longer. This could end up costing you more money, even if the mortgage interest rate is lower: 

• The total repayments for a $300,000 mortgage over 20 years at 4.50% is $455,508
•  The total repayments for a $300,000 mortgage over 30 years at 4.00% is $515,609
• That's a difference of over $60,000!

Hypothetical examples are for illustrative purposes only. Does not account for fees or interest rate changes over time. Source: MoneySmart.

Conducting regular home loan health checks is a no-brainer. Comparing home loans is quick, simple and free, plus there's no obligation to refinance.

Conducting your own home loan health check might reveal that there are alternative loans out there with mortgage rates, fees and features that could save you literally tens of thousands of dollars over the lifetime of your loan.

If you’d like some help conducting your home loan health check, you could consider contacting a mortgage broker. These home loan experts can look at your current home loan and financial situation and make personal recommendations of mortgage offers that may better suit your goals and situation, including exclusive home loan deals that aren’t typically advertised.