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Refinance Interest-Only Home Loans

Name: Refinance Interest-Only Home Loan
Creator: Savvy
Published: 2021-03-25T11:51:57+10:30

Are you looking to refinance your interest-only loan? Read about what they are and the benefits of switching loans with Savvy.

No obligation. It won't affect your credit score.

Written by , updated on August 8th, 2023

You may be thinking of refinancing your interest-only loan for one of many valid reasons. However, one of the most common reasons is because your fixed-term interest-only loan is about to expire and you’re considering your future options. It’s important to understand what your options are, so you can compare a range of offers right here with Savvy to help make your refinancing decision far simpler.

What are my options for refinancing my interest-only loan?

Refinancing essentially involves paying off and closing your previous loan and replacing it with a new loan. You may choose to do this to access a loan which offers you interest savings or improved features, or simply to extend your repayment period.

You have three basic options available to you when refinancing: either extend your current interest-only period, refinance to another interest-only loan or switch to a principal and interest loan.

Extending your existing interest-only loan for a further fixed period is a popular option amongst borrowers. You can extend your interest-only term up to 15 years in length with some lenders, which you can compare right here with Savvy to help find the best offer for you.

How do I refinance my interest-only loan?

Refinancing your interest-only loan with another lender will require you to go through the same application process that you would normally go through with any other standard home loan. If you approach a new lender, they’ll require all the normal documentation to assess your loan suitability, such as proof of ID, income and expenditure details. You can expect the process to take at least a week or two.

Refinancing or extending your fixed-rate period with the same lender will typically be quicker because you’re a known client and already own the asset you’re requesting finance for. Additionally, your current lender will have all your required documentation on file already, so there isn’t likely to be a need to resubmit them. As such, if you decide to remain with your current lender and simply switch to a loan that offers a lower refinance rate or more features, the application process may only take a few days.

Before you decide to switch lenders, make sure you’ve done plenty of research and compared as many offers as possible here with Savvy to help you make an educated decision on which option is best for you.

Why should I refinance my interest-only loan?

The main benefit of refinancing your interest-only loan to another interest-only loan is that you may find a loan with a lower interest rate, which could save you tens of thousands over the life of the loan. It also allows you to extend your interest-only repayment period. Taking advantage of a substantially lower interest rate can offer far greater savings and offset the cost of any early exit fees you may be charged.

What are the advantages of switching my loan to principal and interest?

In addition to the significant savings you can benefit from with a refinance, you can also enjoy the following advantages of refinancing directly to a principal and interest loan:

Pay off your loan sooner and save

When you start paying principal and interest on your loan, you’ll have the satisfaction of knowing the amount you owe the bank is gradually reducing. In addition, as you only pay interest on the total amount you owe, the interest you pay will reduce more quickly as your outstanding principal shrinks. Throughout the time you’re paying only interest, your overall debt isn’t reducing.

Access handy additional loan features

A principal and interest loan will give you more options when it comes to choosing additional handy loan features, such as an offset account, redraw facilities or the ability to make lump sum repayments. These features can all add flexibility to your repayments, while they also all provide options to help you reduce the overall cost of your loan.

Build up equity in your home faster

By paying off the principal and interest on your loan, you’re building up equity more quickly in your home. This is calculated by subtracting the amount you owe on your loan from the market value of your property. Having higher home equity can potentially give you access to more funds sooner, which you can access if you choose to refinance again.

Is refinancing my interest-only loan right for me?

The reasons why you originally decided on an interest-only loan will influence your decision about how to refinance. People looking to refinance may include:

Owner-builders

Although not all construction loans are interest-only loans, owner-builders can benefit from only paying interest on the actual drawdown amount their builder has been paid during the construction phase of their house; interest-only construction loans are a popular way to save on payments whilst your house is being built. However, once construction is complete, it can be a good idea to refinance the loan to a principal and interest (P&I) loan so you can gradually reduce the amount you owe your.

First homebuyers

The same applies to first homeowners who may have been offered an interest-only loan period when they were first approved for their mortgage finance deal. This interest-only period may have been of great assistance when moving into a new home, but most homeowners will be better off switching to a P&I loan as soon as they can afford higher repayments, ideally even before the ‘honeymoon’ period is over.

Investors

Investors have more viable options than owner-builders and first homebuyers. High income-earners wanting tax offset benefits may be better off refinancing to another interest-only loan with a lower interest rate, as the full repayment amount on the loan can be claimed as a tax offset. Investors may also prefer an interest-only loan if they are planning to sell their investment property in the short-term and wish to reduce their expenses considerably whilst preparing to sell. If you’re looking to keep your property in the long-term, though, you’re likely to be better off with a P&I loan.

Frequently asked questions about refinancing an interest-only loan

Can it be worthwhile breaking a fixed-term interest-only loan despite early exit fees?

Yes – it can be worthwhile paying early exit fees (also known as loan break fees) if you can find a loan with a substantially lower interest rate, or switch to a principal and interest loan which would enable you to pay off your loan much sooner. Paying off your loan sooner will reduce the interest you pay overall, saving you more money in the longer term.

If I want to refinance my interest-only fixed-term loan, how much will my early exit fees be?

Banks use this formula to calculate break fees:

Break fee = loan amount x remaining fixed term x change in interest rate

As an example, a first homeowner has a $350,000, three-year fixed term interest-only loan with a 5% p.a. interest rate. After two years, they decide to refinance to a principal and interest loan with a 2.5% p.a. interest rate. The bank uses this formula to calculate their break fee:

Break fee = $350,000 x 1 x 2.5% = $8,750

How can I ensure my loan refinancing application is processed quickly?

Make sure you supply your lender with all the necessary documents as quickly as possible and ensure they are up to date and accurate. If you have a more complex financial situation, such as not having the required documentation or struggling with your credit score, this is likely to complicate things and slow the process down.

Can I refinance my interest-only loan to take advantage of rising house prices?

Even though you’re not paying off the principal of your loan, you still may be able to benefit from the equity you now have in your home due to rising house prices.

For example, say you bought your home two years ago for $425,000. You took out a loan with fixed interest, paying interest-only for five years, after which it reverted to a P&I variable rate loan. However, in the space of two years, house prices have risen significantly and your home is now worth $480,000. A lender may agree to refinance your loan based on its new valuation, giving access to an additional $55,000.

I’m concerned about my ability to maintain repayments when my loan reverts to principal and interest. What should I do?

Talk to your lender about your financial concerns. They’ll likely request updated financial documents to understand your situation. Your lender may look into hardship provisions and give you the option of extending your interest-only period so you can get your finances in order. You could also look to refinance to a P&I loan with lower repayments than those to which your current loan is set to revert.

Can I refinance to a fixed or variable rate loan?

Yes – you can refinance your interest-only mortgage to a new loan with either a fixed or a variable interest rate. Which option is right for you at this point in time depends on what type of borrower you are and what your home loan goals are.