As we enter a new year, you might be reassessing your finances and wondering whether now is the right time to refinance. Refinancing your home loan is a momentous decision and should not be taken lightly. There are many reasons why you might be eager to find a better home loan deal elsewhere, which we’ll cover in this article.
However, it’s essential to set realistic expectations to refinance your home loan. If you seek to reduce your interest rates by half, you’re likely to be dissatisfied when you find that no lenders are offering such loan terms. Speak to your mortgage broker about what to expect from new loans.
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What Is Refinancing?
Refinancing a home loan is the process of replacing your current loan with a different mortgage from a new lender. Homeowners refinance for many other reasons, from increasing their long-term savings to getting all the features they were denied on their initial loan application.
When we buy our first home, we’re not always in the best financial position. Therefore, the loan terms aren’t necessarily favourable later in life. However, if you are keen to refinance, it’s vital to check your current home loan contract. There are often costs involved with switching home loans; you don’t want to lose out by paying break costs or exit fees.
Let’s get into the reasons why 2022 might be the year for refinancing your home loan.
1. Increase Long-Term Savings
The primary reason for home loan refinancing is to increase your long-term savings. As mentioned, many first-time owner-occupier buyers are not in the best financial situation when they apply for a home loan. Now, years later, your financial situation might be a lot stronger. You can save money with a lower interest rate by refinancing your home loan.
For example, if your interest rate is currently 3% on a $400,000 loan amount, you should expect to pay $207,110 over a 30-year loan term. However, after five years, with only 25 years left and a $396,550.72 loan balance left to pay, you refinance to a loan with a 2.10% interest rate.
You’ll reduce the total remaining interest repayments to $113,501. This would save you $88,627 in interest repayments throughout the loan’s lifetime.
This is quite a significant reduction in interest rates and results in substantial savings. However, slight the interest rate change, you’re bound to lower the entire loan cost. Plus, with lower interest rates, you might be able to pay the loan off sooner – a goal many of us dream of.
It’s also worth taking note that interest rates are at a record low currently, making 2022 an excellent year for refinancing your home loan.
2. Switch to Interest Only or Fixed Rate
Many lenders offer a fixed interest rate or interest repayments only home loans for up to five years. While not suited to everyone, an interest-only or fixed-rate loan can provide significant relief from the financial burden for some.
A fixed-rate loan means that the lender sets the interest for a fixed rate period – usually between one and five. A variable rate loan will have fluctuating interest rates as the market rate goes up and down. On the other hand, a fixed-rate home loan promises uniform monthly repayments over a set term.
You might miss out on lower rates, but you will also be saved when the market rate increases.
Similarly, an interest-only home loan is where the borrower only pays interest for the first few years of the loan. After that period is up, they deliver both principal and interest repayments for the rest of the loan’s lifetime. This might suit some homebuyers who need to free up cash in the short term or reduce their monthly repayments.
You can renegotiate these loan features by refinancing your home loan and enjoy an additional five years of interest-only repayments or fixed-rate mortgage. However, take the time to consider whether these types of home loans are suited to your situation. While they might seem attractive, check the comparison rate of each loan as sometimes they can cost more money than they save.
3. Pay Your Home Loan off Sooner
Whether you reduce your interest rates, increase your monthly home loan repayments, negotiate new loan features, you’ll likely be able to pay off your home loan sooner. Paying off your interest just a few years early can save you thousands of dollars.
If we take the above example, by reducing the interest rate after five years to 2.10%, the monthly repayments decrease from $1,499 to $1,486. However, continue to pay the higher amount each month (an extra $13 a month is an additional $156 a year). You’ll find yourself paying off your loan more quickly without creating a substantial financial burden in the short term.
You could save $1,812 and cut your loan by four months in this scenario. This is just a small saving; can you afford to make additional extra repayments? An extra $40 a month could save you a year. Use our repayment calculator to determine how much you can save on your home loan.
Another way to reduce the life of your loan is to change your repayment frequency on your existing loan. Making loan repayments every two weeks rather than every month could cut your loan short significantly. Firstly, interest rates are calculated daily. More frequent repayments could result in taking advantage of a lower interest rate.
Secondly, there are 26 fortnights in a year. If you make 26 payments rather than just 12, you effectively pay a whole extra month each year. However, some lenders adjust your payment amounts for fortnightly mortgage repayments. It’s best to consult your current lender about whether changing repayment frequency is a good choice.
4. Pay Off Other Debt
Beyond your home loan, you likely have other debts. For example, you might have a car loan, credit card, and a personal loan. Making individual regular payments to each could become confusing and difficult to manage. Therefore, you might consider a home loan refinance to consolidate your debt. You can use the extra funds to pay off all the other loans involved by negotiating a higher loan amount.
However, the downside of debt consolidation with your home loan is that you might end up paying more in the long term. By increasing your mortgage loan balance, you’ll also increase the amount of interest you pay. As the most extended loan term, the interest repayments can build up to a significant additional payment.
If you’re thinking of consolidating debt with your home loan, then seek independent advice about whether it’s a good decision.
5. Get Rid of LMI
House prices in Sydney are at a record high. With asking prices nearing an average of $2,000,000 in some neighbourhoods, deposits are expected to be around $400,000. This is a significant lump sum for a first-time buyer. Many cannot get onto the property ladder in such a competitive and expensive market.
However, lenders allow homebuyers to borrow money with a deposit of less than 20%. They base their lending decision on your Loan to Value Ratio (LVR). This is calculated by dividing the loan amount by the property value and presenting it as a percentage.
If a first-time buyer has a deposit of $100,000 for a property worth $1,000,000, then they need to borrow $900,000. Their LVR would be 90%. For all LVR higher than 80%, lenders require borrowers to pay Lender’s Mortgage Insurance. This is a hefty additional payment and can significantly increase the cost of your loan.
Therefore, if you were saddled with LMI when you applied for your home loan, it’s understandable that you’re refinancing your home loan to remove this additional cost.
However, bear in mind that if you don’t have 20% equity on your property when home loan refinancing, then you might be expected to take out LMI once more with your new lender. Also, remember that you won’t get a refund on LMI payments already made.
6. New Loan Features
Another reason to refinance your home loan is to access additional features. Strong applicants are often offered features such as an offset account or redraw feature that helps them save money.
An offset account is basically a transaction account linked to the home loan account. Essentially, it is an everyday bank account. You can deposit, withdraw, and save money. The benefit is that any funds kept in the transaction account are offset against the interest you pay on your loan amounts.
For instance, let’s take the earlier example of a $400,000 loan amount at a 2.10% rate. By maintaining an average of $100,000 in your offset account, you could save yourself $5,377.25 in interest and shave sixteen months off your home loan.
The downside is that offset accounts might come with ongoing fees. If you don’t keep a worthwhile sum in your transaction account, then the feature might not do you any favours.
A redraw facility is similar. If you ever make extra repayments on your home loan, you can take back any extra money should you run into a sudden need for cash.
Redraw and offset features are often only offered to those with an LVR lower than 80%. Therefore, you might meet eligibility criteria if you refinance once you have paid off more than 20% of the property.
7. Refinance to Renovate
Finally, some choose to refinance to borrow extra funds to renovate. If your home requires major structural work or you want to make a significant addition to the property, some lenders will allow you to refinance to fund the project. Often, lending criteria establish that the house value must be higher once the renovation is complete.
While increasing your loan amount and term, you aim to make your money back when you sell the property for a higher price.
Not every lender will offer this option; if your existing lender does not, speak to a mortgage broker about whether you might refinance elsewhere.
Reasons Why You Shouldn't Refinance
Refinancing isn’t for everyone. If you’re satisfied with your current home loan, there is no reason to change home loans. It’s not an easy process and, without doing proper research and shopping around, you may end up with a worse deal.
Before you approach your financial institution to discuss refinancing your home loan, ask yourself your motivations for doing so. If you want to make significant long-term savings and you’re in a better financial position than you were when you took out the loan, then it’s worth pursuing.
However, if you want short-term cash or are pressured by others to refinance, then it may be the wrong decision. If you’re in doubt, speak to an expert. Let’s go through a few reasons refinancing might not be the right choice.
Improve Short-Term Cash Flow
Refinancing should be about your long-term goals. If you’re thinking of what you can get out of home loan refinancing in the short term, then perhaps this is a sign that you should rethink your decision.
Applying for a new home loan with lower monthly repayments and a longer-term might seem an attractive prospect. However, this will increase the amount you pay throughout the entire home loan. While you might need the cash in the short term, it could come back to bite years down the line.
The same is true of refinancing to interest-only loans. While in the short term, you’ll pay lower monthly repayments, your principal will go unpaid. Therefore, the length of your loan and overall interest repayments will increase.
If you require cash or want a repayment holiday, speak to an expert. If your credit is strong enough to refinance, then you’ll likely meet credit criteria for other kinds of loans that could fix your cash flow problem. There are usually better ways of raising capital quickly than interfering with your home loan.
Of course, if you intend to release cash from your home loan to put it back into your mortgage, then it might work in your favour. It’s crucial to consider all your options carefully.
Cash Out for Quick Spending
While it can be tempting to cash out funds to pay for a vacation or another significant sum, this is a short term relief. In the long-term, you might regret spending your home equity on unwise investments. You should weigh up what is worthwhile to you. Just make sure that you’re making smart financial decisions for your situation.
Because Others Are Doing It
Perhaps the worst reason for refinancing your home loan is others do it. You might hear of friends and family discussing refinancing. However, their excellent deals aren’t necessarily the same as what you would get if you refinanced. Everyone’s financial situation is different, and everyone’s home loan is different.
You must consider your situation before deciding to refinance. What’s suitable for others might not be right for you.
Plus, take care to avoid being pressured by lenders. Some lenders might offer what looks like a better home loan deal. Yet, when you look at the terms, you might find that you’re expected to pay more than you expected. For example, the lender might offer lower interest rates but make up the difference in a mortgage registration fee and closing costs.
Therefore, you must check out the comparison rate of all home loan options before committing to a lender. Plus, always check their Australian credit licence number to check that they’re reliable. Working with a mortgage broker will save you time, effort, and money if you choose to refinance.
Is Refinancing Right for You?
There are many reasons why refinancing is an excellent financial decision in 2022. However, you must assess your financial situation and current loan first. The thought of lower interest rates might seem attractive but if you have to pay exit fees to your existing lender to switch loans, then ask yourself whether it’s worth it?
Ensure that you calculate how much money you can save in the long term by refinancing and whether you can avoid any short-term costs. Everyone wants to pay their home loan off early. However, you don’t want to get carried away refinancing and discover down the line that you have made a mistake.
Yet, if your credit is strong and you have done your research, then refinancing could save you thousands of dollars on your home loan.
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What Is the Point of Refinancing?
Refinancing your home loan can help you save money in the long term. Refinancing can save you thousands of dollars by reducing interest rates, paying off your mortgage sooner, and negotiating additional features. Plus, many homeowners refinance to release equity on their property for renovations or other large payments.
Set a realistic goal of what you can expect from refinancing.
How Much Can I Refinance on My House?
Generally speaking, you need at least 20% equity on your property to refinance. If you refinance with less than 20%, you may have to pay Lender’s Mortgage Insurance and face higher interest rates. Depending on the lender and your credit score, you should still be able to refinance as much as 95% of the property’s value.
What Is a Good Credit Score to Refinance a Home?
The higher your credit score, the more money you can borrow and the lower the interest rates. While there is no magical number that will secure you excellent loan terms when refinancing, it’s generally considered that credit scores above 600.
If you have a poor credit history, however, there are still many lenders who will offer favourable rates. Still, you may need the assistance of a mortgage broker.
Does Refinancing Hurt Your Credit?
When you take on new debt, your credit score may dip slightly. However, as long as you make regular payments and stay in line with the terms of your loan, the impact on your credit score should be minimal. If you refinance a lot, then the lender might make a hard credit inquiry before approving your application. This could harm your credit score.
How Much Does It Cost to Refinance?
The cost of refinancing depends on your current loan terms. For example, if you have to pay exit fees or other closing costs, the process might be more expensive. You might expect to pay anywhere between 2-5% of the loan principal. It’s worth considering whether refinancing saves you more money in the long run.
What Do You Need to Refinance Your House?
To refinance your property, you will need to share evidence of your identity, income, property details, and information about your current loan with the lender. You might also need to disclose any other debts or financial obligations you have. If you ready all your supporting documents, refinance should take between one to two months.
Does Refinancing Lower Interest Rate?
Often, homeowners are in a better financial situation a few years after purchasing their home. With a stronger credit score, you should be able to negotiate lower interest rates and loan terms. However, it’s essential to consider the comparison rate, as lower interest rates don’t always correlate to a better loan deal.