Refinancing your home loan could save you thousands of dollars

Refinancing your home loan could save you thousands of dollars

You’ve been with your bank for years, so they’ll definitely give you a good deal on your home loan, right?

Not necessarily. Banks are loyal – but to their shareholders, not their customers. That doesn’t mean they’ll give you bad service; many banks provide excellent service. But banks, like any other business, exist to make profits. So you can’t assume they’ll reward you for your loyalty.

Veronica* was shocked when she discovered that her bank, where she’d been a customer for years, was charging her more in interest for her home loan than some other lenders in the market. So she decided to refinance and take her business elsewhere.

Thinking about switching? Read RateCity’s Refinancing Guide.

Refinancing to a cheaper home loan

Veronica was five years into a 30-year home loan. Originally, she’d borrowed $400,000 to buy a $500,000 property, giving her a loan-to-value ratio (LVR) of 80 per cent. Now, after five years, her loan had been reduced to $366,000, while her property had climbed in value to $600,000, giving her an LVR of 61 per cent.

Most mortgage lenders prefer to work with borrowers who have LVRs of 80 per cent or less, so you could be in a good position to refinance if you have at least 20 per cent equity in your home. If, like Veronica, you have 39 per cent equity, your position might be even stronger.

After comparing home loans from a range of big banks and challenger institutions, Veronica decided to refinance with UBank, an online lender.

Low interest rates are one factor to look for when refinancing, as it could potentially save you thousands of dollars over the course of your mortgage.

For example, Veronica’s current lender was charging her 3.38 per cent interest. By switching to UBank, Veronica reduced her home loan interest rate to 3.09 per cent (comparison rate also 3.09 per cent)^. This interest rate is scheduled to fall to 2.84 per cent on 29 October, due to the recent Reserve Bank rate cut. Even before the coming rate cut, Veronica could be on track to save more than $17,000 over the final 25 years of her mortgage (assuming the same interest rate for the rest of the mortgage term, which is unlikely).

As with all financial products, it’s important to weigh up various home loan interest rates before signing the dotted line. Apart from interest rates, the time you invest to do your research in the loan’s fees and features will pay off in the long run.

Can you avoid pesky fees?

When Veronica compared loans, she knew she wanted to reduce the amount of fees she was paying.

UBank doesn’t charge application fees for its variable home loan (although Veronica’s previous lender imposed a $350 discharge fee when she closed her mortgage). UBank also doesn’t charge ongoing monthly or annual fees, which means all the money Veronica contributes to her mortgage goes to paying it down.

Another reason Veronica chose UBank was because it doesn’t charge her a fee to use the redraw facility and won’t charge her a discharge fee when she gets to the end of her home loan.

There are a range of upfront and ongoing fees your lender may be charging you. If you're considering refinancing your home loan, don't forget to compare potential fees and additional costs so you can reduce more than just your interest rate.

Why you might not want to refinance

Refinancing can be a smart move for some borrowers, but it’s not for everyone.

  • If you feel like you’re getting good service and good value from your mortgage lender, there might be no reason to go elsewhere.
  • If you’re concerned your interest rate is a bit high, you might be able to get it lowered just by calling your lender and threatening to take your business elsewhere if they don’t cut your rate.
  • If you’re near the end of your mortgage, any savings you might make by switching to a cheaper home loan might be outweighed by the time and money you need to invest in refinancing. 

The other point borrowers should consider is that while interest rates are important, they’re not the only thing you need to consider when comparing home loans. Other factors, such as fees, loan features and customer service, are also important.

* Veronica is not a real person. This is a hypothetical case study.

^ Data accurate as of 11 October 2019.

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Learn more about home loans

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

How do I refinance my home loan?

Refinancing your home loan can involve a bit of paperwork but if you are moving on to a lower rate, it can save you thousands of dollars in the long-run. The first step is finding another loan on the market that you think will save you money over time or offer features that your current loan does not have. Once you have selected a couple of loans you are interested in, compare them with your current loan to see if you will save money in the long term on interest rates and fees. Remember to factor in any break fees and set up fees when assessing the cost of switching.

Once you have decided on a new loan it is simply a matter of contacting your existing and future lender to get the new loan set up. Beware that some lenders will revert your loan back to a 25 or 30 year term when you refinance which may mean initial lower repayments but may cost you more in the long run.

What is an ongoing fee?

Ongoing fees are any regular payments charged by your lender in addition to the interest they apply including annual fees, monthly account keeping fees and offset fees. The average annual fee is close to $200 however there are almost 2,000 home loan products that don’t charge an annual fee at all. There’s plenty of extra costs when you’re buying a home, such as conveyancing, stamp duty, moving costs, so the more fees you can avoid on your home loan, the better. While $200 might not seem like much in the grand scheme of things, it adds up to $6,000 over the life of a 30 year loan – money which would be much better off either reinvested into your home loan or in your back pocket for the next rainy day.

Example: Anna is tossing up between two different mortgage products. Both have the same variable interest rate, but one has a monthly account keeping fee of $20. By picking the loan with no fees, and investing an extra $20 a month into her loan, Josie will end up shaving 6 months off her 30 year loan and saving over $9,000* in interest repayments.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

How can I negotiate a better home loan rate?

Negotiating with your bank can seem like a daunting task but if you have been a loyal customer with plenty of equity built up then you hold more power than you think. It’s highly likely your current lender won’t want to let your business go without a fight so if you do your research and find out what other banks are offering new customers you might be able to negotiate a reduction in interest rate, or a reduction in fees with your existing lender.

What is an ombudsman?

An complaints officer – previously referred to as an ombudsman -looks at formal complaints from customers about their credit providers, and helps to find a fair and independent solution to these problems.

These services are handled by the Australian Financial Complaints Authority, a non-profit government organisation that addresses and resolves financial disputes between customers and financial service providers.

How much of the RBA rate cut do lenders pass on to borrowers?

When the Reserve Bank of Australia cuts its official cash rate, there is no guarantee lenders will then pass that cut on to lenders by way of lower interest rates. 

Sometimes lenders pass on the cut in full, sometimes they partially pass on the cut, sometimes they don’t at all. When they don’t, they often defend the decision by saying they need to balance the needs of their shareholders with the needs of their borrowers. 

As the attached graph shows, more recent cuts have seen less lenders passing on the full RBA interest rate cut; the average lender was more likely to pass on about two-thirds of the 25 basis points cut to its borrowers.  image002