Should I Refinance My Home Loan?
Fact checked
You might’ve hit a point in your home loan repayment where you’ve had enough of your current terms and want to start looking for newer, better deals. A home loan refinance could be the solution to your problems. In this guide, we delve into home loan refinancing and analyse the different ways it can benefit you. Read on to find out more.
Why should I refinance my home loan?
There are a number of reasons that could lead someone to want to refinance their mortgage. We’ll outline some of the most common motivating factors behind borrowers seeking a refinance and how they can benefit you.
You want access to a better interest rate.
Many people refinance their home loan to get a better interest rate. This can apply to variable rate borrowers looking to switch lenders for more favourable conditions or to those paying off a fixed rate period of their home loan who may have locked their rate in at an unfortunate time. Doing so could reduce your monthly repayments considerably and save you thousands in the long run in the right circumstances. For example, you’ve borrowed $400,000 over a 30-year period and fixed your interest rate at 3.5% for five years. However, with three years left on your fixed term, you find a home loan at 3% that you’d like to switch to. Your potential savings situation could be as follows:
| Current interest rate | Monthly repayments | Total repaid over three years | Potential saving |
|---|---|---|---|
|
3.5% |
$1,796.18 |
$64,662.48 |
– |
|
3% |
$1,686.42 |
$60,711.12 |
$3,951.36 |
The important thing to note with breaking fixed rate home loans to access a better interest rate is that you’ll usually incur a significant break fee as a penalty for exiting the agreement early. This fee could actually end up costing you money by outweighing the saving you’d make on a lower interest rate. However, you might decide that the long-term benefit is great enough to merit a switch.
The value of your property (and the size of its equity) has increased, so you can buy an investment property.
If your property’s value has appreciated over the course of your loan term, it could mean that, in combination with your regular repayments, your home equity has grown enough to qualify you for a home loan on better terms without having to pay for costs such as Lender’s Mortgage Insurance (LMI). Equity is calculated by subtracting your outstanding debt from the value of your property, so a growth in value and a drop in debt will accelerate the increase in equity. For example, you could see a situation like this occur over time in the right circumstances:
| Property value | Amount owed | Total equity | |
|---|---|---|---|
|
NOW |
$500,000 |
$300,000 |
$200,000 |
|
TEN YEARS LATER |
$700,000 |
$200,000 |
$500,000 |
Refinancing to access equity is a common reason why borrowers pursue this avenue. Another of the primary reasons for doing so is to facilitate the purchase of investment property that you otherwise wouldn’t have been able to finance. We'll use the example above to demonstrate this:
You’ve owned your property for a while now and the combination of your repayments and its appreciating value has built your home equity to $500,000. You want to purchase a $900,000 house as an investment property, so you negotiate with your lender to borrow against your home equity to finance the purchase of the property. Your lender determines that your usable home equity stands at $400,000, so you decide to use $300,000 of that to fund a sizeable 33% deposit on the property. You agree to refinance your home loan and accept a new term of 30 years. This allows you to continue to pay off your remaining debt from your first property alongside the cost of your new property.
Your financial situation has changed and you want to pay off more of your home loan.
If you’ve earned a promotion at work or moved into a new, higher-paying job, you might now be capable of making larger contributions to your home loan each month. In this position, you may wish to seek out a different lender who can offer you the opportunity to repay the rest of your loan over a shorter period. Not every lender will allow you to do this, as many will only offer repayment periods of 30 years, but you’ll be able to find lenders on the market that do.
The move to a shorter term will likely mean higher monthly repayments but you’ll have your loan paid off earlier, which could result in saving a significant amount in interest over the life of your loan.
You want to finance renovations for your home.
Renovations can be an attractive, or even necessary, upgrade to your home that can increase its value. Refinancing your house and home loan can be a great way to fund improvements on your house if you’re unable to pay for them out of your savings. Essentially, doing so involves finding the right loan or lender and applying for a home loan with similar or better conditions to your current one, but with a slightly greater loan amount to cover the cost of your renovation. As is the case with other refinancing needs, you should try to avoid breaking your home loan’s fixed rate period where possible if it’ll incur a considerable break fee.
You want to consolidate your existing debts.
Multiple different debts on your plate at once is hardly an ideal situation to have to balance, especially if they’re all on unique payment cycles. Bringing all of those debts under one roof can make your repayment commitments much more straightforward and easier to manage, as well as reducing your monthly repayments. The below example outlines how your finances might look after consolidating your debts.
| Amount owed | Interest rate | Loan term | Monthly repayments | |
|---|---|---|---|---|
|
Home loan |
$400,000 |
4% |
30 years |
$2,147.29 |
|
Personal loan |
$40,000 |
7.5% |
7 years |
$613.53 |
|
Credit card #1 |
$10,000 |
17.5% |
2 years |
$490* |
|
Credit card #2 |
$7,500 |
15% |
2 years |
$359* |
|
Consolidated home loan |
$457,500 |
4% |
30 years |
$2,184.17 |
|
|
|
|
Savings per month after consolidating: |
$1,425.65 |
*represents the fastest time to repay each credit card debt
You want to use funds for your business.
You can also use equity in your home to put funds towards either an established or start-up business. The most efficient way to do this is to establish a line of credit for working capital, marketing, to enable the purchase of new equipment or any other expenses required for your business. Business start-ups can be difficult, so finding the right loan to switch to and unlock the equity in your property could be the stepping stone you’re looking for to advance your business aspirations.
You want more time to pay off your loan.
If your mortgage repayments are starting to catch up with your finances, you might have the option to negotiate a longer loan term to switch to. This will enable you to save more on monthly repayments but will likely end up costing you a considerable amount in interest and fees in the long run. Overall, it’s always best to limit the amount of time you’ll be paying off your home loan where possible.
Which fees do I have to look out for if I refinance my home loan?
As a rule of thumb, you should always keep your eye on fees when you decide to refinance your mortgage. Bear in mind also that asking for certain fees to be waived can form part of the negotiation process with lenders, as they’re just as keen to gain your business as you are to be approved for their loan.
|
Discharge Fee |
A fee that applies when you are discharged from your existing home loan. These are generally present when you switch to another lender, rather than changing loans with the same one, and can cost between $150 and $400. |
|
Break Fee |
Applying exclusively to fixed rate home loans, you’ll be charged a hefty fee for breaking the home loan agreement with your lender. If you want to keep your options open in the future, look for lenders who waive break fees on their home loans. If you took out your loan before July 1, 2011, your lender may still be able to charge a break fee regardless of the type of loan. |
|
Application Fee |
The fee you’ll need to pay when applying for your new home loan. It’s likely to cost you another $150-$700, but many lenders will be willing to waive it. |
|
Switching Fee |
This is a cost that your lender may charge you if you look to transfer to a different loan that they offer. |
|
LMI |
You may need to pay for LMI with your new home loan application, depending on loan-to-value ratio (LVR). Try to avoid bringing your LVR back up above 80% if you wish to avoid paying thousands of dollars for LMI on your new home loan. |
|
Settlement fee |
This cost will likely be charged to you by your new lender, which are used to cover the settlement of the new contract between you and them. |
The pros and cons of refinancing your home loan
PROS
Lower rates, lower repayments
You may be able to get a lower interest rate, which means lower monthly repayments.
Change your loan length to suit your needs
You’ll usually be able to lengthen or shorten your mortgage, depending on the terms of your new home loan. This can help update your loan to better suit your current financial situation, as needs evolve over time.
Unlock your equity
When you refinance your home loan, you can enable access to the equity in your home, which can help you buy investment property or renovate your current home.
CONS
Paying your fees again
You’ll probably have to repay some of the one-off fees you paid at the start of your previous home loan, such as the application fee, settlement fee and more.
Longer mortgage = more interest
Lengthening your mortgage means you may end up paying more interest on your loan in the long run.
