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What is refinancing?
Refinancing is when you move your home loan from one lender to another lender - often to take advantage of a lower interest rate.
For example, you might move your home loan from Lender A to Lender B, because the former is charging you 4.50 per cent interest while the latter has a comparable mortgage for just 4.30 per cent.
Should I refinance my mortgage?
If your home loan costs you more per month than you’d prefer to pay; if want to be out of debt sooner; or if want to put the equity in your home to use, you may want to calculate whether refinancing your mortgage will suit your finances.
The refinance calculator is a great tool to help you calculate how much you can save when switching your home loan, and work out whether refinancing your mortgage is a strategy that will suit you and your finances.
Using the calculator, you can calculate your potential savings based on three different refinancing goals:
1. Reduce my repayments
If you simply want to pay less in home loan repayments each month, you can enter your current monthly repayment, outstanding loan amount and current interest rate into the refinance calculator to work out the following:
- Current loan term: The length of time it will take to finish paying off your home loan at your current rate.
- Cheaper loans: Alternative home loans with cheaper monthly repayments.
- Potential savings: By defining a time frame (e.g. three years), you can calculate how much you could save over that time frame by switching home loans.
2. Pay off my loan faster
If your goal isn't to pay less on your mortgage each month, but to pay off your home loan more quickly, refinancing can still be a great option for you.
By selecting this saving goal, the refinance calculator keeps your current monthly repayment fixed at the same amount. When you switch to a loan with lower minimum repayments, the savings can instead go towards paying off your loan’s principal.
This means a bigger portion of each home loan payment can go towards clearing your loan's principal rather than covering the interest charges, thus your home loan can be paid back quicker.
Paying your home loan quicker can mean saving a lot of money in interest charges. When you set your refinancing goal to "Pay off my loan faster", the refinance calculator will show how much you'll save on interest charges in total.
Nick owes $350,000 on his mortgage with a 4.5 per cent interest rate, which he’s paying back in $1,881 monthly instalments. At this rate, he’ll be out of debt in 26 years and 8 months.
By using the refinance calculator and selecting “Pay my loan off faster” as his goal, Nick learns that by switching to a home loan with a lower interest rate of 3.79 per cent, but continuing to pay $1,881 per month, he could potentially repay his loan 3.2 years sooner, and save $112,800 in total interest charges.
3. Get cash out of my home
If you're considering renovating your place, consolidating other debts, or making a major purchase, refinancing your home loan could allow you to access the funds you need.
If the value of your property has gone up since you took out your home loan, you may be able to refinance and access some of these capital gains as cash, or use this equity as security to borrow more.
While interest rates for personal loans can range between 10 to 20 per cent, a home loan interest rate could be less than 4 per cent, so borrowing a bit more on your home loan could cost you less in interest from month to month than taking out a personal loan.
Remember that while mortgage interest rates tend to be much lower than those of personal loans, home loans are typically repaid over much longer loan terms – you may be comparing apples with oranges.
While you may pay interest at a lower rate by adding to your home loan, you may end up paying more interest in total over the long-term than you would by taking out a separate personal loan.
Cash Out & Monthly Repayment
When selecting "Get cash out of my home" as a refinance goal, the calculator will allow you to enter how much money you want to access with your home loan, and show you how much you'll be paying each month towards this new home loan amount by switching to different lenders.
What are the pros and cons of refinancing?
Here are three of the pros of refinancing:
- You could save money if you switched to a home loan with a lower interest rate and/or lower fees
- You could find it easier to manage your mortgage if you switched to a loan that was more flexible (e.g. offset, redraw, split interest
- You could reduce your loan-to-value ratio (LVR) if you did a valuation during the refinance process and found out your home had risen in value since the last valuation
- You could save money
- It could be easier to manage your loan
- Your loan-to-value ratio might fall
- You could lose money
- It could be harder to manage your loan
- Your loan-to-value ratio might rise
Here are three of the cons of refinancing:
- You could lose out if the money you saved in lower interest charges was exceeded by the fees accrued during the refinancing process
- You could find it harder to manage your mortgage if your new home loan was less flexible
- You could be forced to pay lender’s mortgage insurance (LMI) if your home had fallen in value and your LVR had been pushed up above 80 per cent
Case study: refinancing done right
Five years after taking out a 30-year mortgage with a big four bank, Mr and Mrs Penny decide to explore their home loan options. Their current mortgage - which has been paid down to $376,000 - comes with an interest rate of 4.30 per cent and an annual fee of $395. After doing their research, Mr and Mrs Penny refinance to a comparable home loan with an online-only lender, which has an interest rate of 3.49 per cent and no annual fee. As a result, the total repayments over the remaining 25 years of their home loan fall from $624,118 to $564,099 - a saving of $60,019. As an added bonus, the official valuation reveals that their property has gained in value during the past five years, so their loan-to-value ratio (LVR) also improves, from 75 to 71 per cent.
How do I refinance my home loan?
Refinancing your home loan will probably involve a similar process to the one you followed when you took out your current home loan.
There are six steps with refinancing:
- Research the market
- Do your sums
- Apply for the new loan
- Wait for the valuation
- Pay off the old loan
- Pay off the new loan
1. Research the market
Compare your current home loan with a wide range of alternatives to find out how yours stacks up. Do your best to compare apples with apples. So if a rival mortgage has a lower introductory rate but then switches to a higher interest rate after, say, 12 months, it would probably be best to
make a comparison with this higher ongoing rate. The same rule would apply if the rival mortgage skipped the annual fee in the first year but applied it thereafter.
2. Do your sums
Once you’ve made a list of potential new home loans, use a refinance calculator to compare the total cost of your current mortgage with the total cost of a rival mortgage. Don’t forget to include switching costs (any discharge fee on your existing home loan and any upfront fees on the new home loan).
For example, if your current mortgage has an outstanding balance of $250,000, an outstanding loan term of 20 years and an interest rate of 4.00 per cent, you’d be looking at total repayments of $363,588 during that 20-year period. If you switched to a home loan with an interest rate of 3.95 per cent, your total repayments would fall to $362,009 - a saving of $1,579. However, if you had to pay $1,600 in switching costs, you would actually lose money by refinancing.
3. Apply for the new loan
If you’ve decided to refinance, you’ll need to apply for the new mortgage. You can initiate the process by using a comparison website like RateCity, visiting a mortgage broker or going direct-to-lender. Your new lender is likely to ask you for the same paperwork you had to provide when you took out the home loan with your old lender.
4. Wait for the valuation
There’s a good chance your new lender will want to do a valuation of your home, as part of the application process. You’d probably have to pay for any valuation. Once the valuation was completed, you would then decide whether you wanted to continue with the application process.
5. Pay off the old loan
If you do, indeed, refinance, your new home loan from Lender B will be used to pay off the old home loan from Lender A. Now, you’d owe the same amount of money (assuming you didn’t refinance to a higher amount), but to a different lender.
6. Pay off the new loan
The repayment process begins - again!
What are the traps of refinancing a home loan?
There are five traps to be wary of when refinancing your home loan:
- Being fooled by special deals on interest rates
- Being fooled by special deals on fees
- Comparing rates but not fees
- Ignoring the costs of a longer loan term
- Getting slugged with lender’s mortgage insurance
1. Being fooled by special deals on interest rates
One ruse that some lenders pull is to advertise an enticingly low interest rate with an asterisk alongside. Imagine your current home loan was charging 4.00 per cent interest; in that case, your head might be turned by a rival lender advertising a comparable mortgage for only 3.80 per cent*. But it might be that this was a special interest rate that applied for only the first 18 months of the loan - and that, afterwards, it reverted to the standard rate of 4.30 per cent.
2. Being fooled by special deals on fees
Imagine your current home loan had 20 years left to run and charged an annual fee of $200 - that means you’d have to pay $4,000 in annual fees over the next two decades. So it might seem like a great deal to refinance to a home loan that had the same interest rate but didn’t charge an annual fee, even if you had to pay $1,000 in switching costs. But what if the fineprint said that this $0 annual fee only applied for the first year - and that, from year two onwards, a standard annual fee of $250 would be charged?
3. Comparing rates but not fees
Moving to a home loan with a lower interest rate sounds like a guaranteed winner. But what if the money you saved in reduced interest payments was actually less than the fees you had to pay to access this lower rate? Imagine that your current mortgage had an outstanding balance of $300,000, an interest rate of 4.20 per cent, no annual fee and 18 years left to run - in that case, your remaining repayments would be $428,055. If you switched to a home loan with an interest rate of 4.10 per cent and an annual fee of $395, your total repayments would actually rise, to $431,794.
4. Ignoring the costs of a longer loan term
Another way a lower-rate loan could cost you money is if you refinance to a longer loan term. For example, if your current mortgage had an outstanding balance of $415,000, a remaining term of 22 years and an interest rate of 4.50 per cent, you’d have to pay $2,479 per month and $654,496 over the life of the loan. If you refinanced to a home loan that charged 4.35 per cent, and extended your loan term to 25 years, your monthly repayments would fall to $2,272 (a decrease of $207), but your total repayments would rise to $681,454 (an increase of $26,958).
5. Getting slugged with lender’s mortgage insurance
Most lenders will do a fresh valuation of your property as part of the refinancing process. There’s a good chance your home may have appreciated since the last official valuation. However, it’s also possible your home may have gone down in value. In that case, it’s possible that your new loan-to-valuation ratio (LVR) will be above 80 per cent, which is generally the threshold lenders use when deciding whether or not to make you pay lender’s mortgage insurance (LMI). For example, if you originally borrowed $400,000 to buy a home that was then valued at $500,000, your LVR would’ve been 80 per cent - so you wouldn’t have been forced to take out LMI. But if you then refinanced with a reduced loan balance of $375,000 and a reduced valuation of $463,000, your LVR would be 81 per cent - so you would be forced to get LMI.
Case study: refinancing done wrong
Ten years after buying their first home, the Johnsons feel the time has come to refinance. Their current variable rate, of 4.00 per cent, is below market average - but they’re still excited when they find a mortgage priced at just 3.80 per cent. They do their sums: with 20 years and $308,000 left on their mortgage, their total repayments should fall from $447,941 to $440,189 - a saving of $7,752. So they switch home loans. Unfortunately, though, they miss the fineprint, which explains that the 3.80 per cent interest rate is just an introductory offer; that after two years, it reverts to the standard rate of 4.25 per cent. As a result, their total repayments actually rise, to $455,919 - a loss of $7,978.
Who does refinancing?
Almost all home loan lenders do refinancing. That includes:
- The big four banks
- Regional banks
- Mutual banks
- Credit unions
- Building societies
- Non-bank lenders
What special deals can I get with refinancing?
The home loan market is competitive, with lenders regularly trying to steal customers from their rivals. So it’s common for lenders to tempt mortgage borrowers with inducements such as:
- Introductory interest rates - interest rates may be reduced for a limited period (such as the first 12 months of the loan)
- Lower fees - upfront fees may be reduced or waived; annual fees may be temporarily removed (such as for the first year)
- Cashback - a one-off payment (of, say, $1,000)
- Gifts - things like holidays, iPads, gift cards, credit card rewards points
What is a home loan refinance calculator?
A home loan refinance calculator is a tool that allows you to see how your mortgage would change under different repayment scenarios.
Here are two possible scenarios if you refinanced to a home loan with a lower interest rate:
- If you kept the same loan term - your monthly repayments would fall
- If you made the same monthly repayments - you’d pay off the home loan sooner
A property and personal finance writer, Nick Bendel covers property, loans, credit cards, superannuation, and other bank products. Nick has previously written for The Adviser, Mortgage Business, Lifehacker, Business Insider, Yahoo Finance, and InvestorDaily, and loves getting elbow-deep in the latest ABS, APRA and RBA data.