Refinancing your home loan might seem like a very good idea, especially if there are low interest rates and attractive cash-back offers on the market in Australia.
And it could be. There are several ways in which refinancing may benefit you – including the opportunity to switch to a lower interest rate than your existing loan, which could lead to reduced repayments or even a shorter loan term.
You could also unlock the equity in your home – to potentially undertake a reno – or add features such as an offset account or redraw facility to your home loan.
But, when it comes to refinancing, you need to think about the full picture of benefit versus cost – from charges and fees, both from your current lender and the new lender, to interest rates over the long term.
It’s critical to do your research, examine your personal financial situation as a borrower, and read the fine print in product disclosure statements and disclaimers to ensure you avoid the common pitfalls.
Here are a few things to look out for before making any financial decisions around refinancing:
Check the upfront and ongoing fees
There may be upfront costs you have to pay for when you refinance, as well as ongoing payments related to the new home loan. Some of the fees that you could end up paying include:
If you are on a fixed rate home loan, then you may have to pay a break cost to your lender for exiting your current loan early.
Break costs are calculated on a case-by-case basis using a formula that can be quite complex. Basically, the calculation takes into account any potential losses made by your lender if the wholesale interest rate on your remaining fixed rate term is less than the wholesale rate that applied at the start of the fixed rate period.
Discharge settlement fee
Keep in mind that you could also be charged a discharge settlement fee (aka a settlement, loan exit or termination fee) for closing your home loan.
This fee is typically charged by lenders to cover the admin required to exit the loan, whether you are refinancing out to a different lender or simply paying out the loan balance – and it can apply whether your loan has a variable rate or a fixed rate.
Application or Establishment fee
This is to cover the admin required to set up a new loan when you refinance.
Property valuation fee
This may be required by a new lender, to get an accurate picture of your equity, and can vary. Some lenders include valuation as part of the application fee.
This is to cover the legal costs of settling a new home loan with the lender.
Mortgage registration fee
This is paid to the state or territory government for registering a new mortgage for the property and varies depending on the location.
You also need to think about any ongoing costs when looking at new home loan products – such as regular monthly fees and/or early repayment fees, which can vary between lenders.
In all, these costs could potentially outweigh a tempting cashback offer or low interest rates, so make sure to scrutinise them with a fine-tooth comb.
You may need to pay Lenders Mortgage Insurance
Lenders Mortgage Insurance (LMI) generally applies to home loans where the LVR (loan-to-value ratio) is over 80 per cent – that is if the deposit you contribute toward the property is less than 20 per cent of the total value. If you paid Lenders Mortgage Insurance to your lender when applying for your current home loan, and your LVR is still higher than 80 per cent, you could end up paying LMI twice over when you refinance.
Weigh up between variable interest rate and fixed rate
Introductory interest rates on variable rate home loans can be very attractive – but once the intro term ends, standard variable rates from the lender will apply, so it's important to know what those rates are. Make sure you factor this into your long-term calculations to get a gauge on whether you will actually end up saving in the long term.
When it comes to a fixed rate home loan, you need to investigate how much flexibility your new provider is offering.
Because in theory, when you refinance to a lower interest rate, you can continue to pay the same amount, or more, in your repayments – which could potentially shave off thousands of dollars in interest, as you pay off the principal (the amount you borrowed) faster.
However, if you refinance to a fixed rate home loan, there may be limits to how much extra you can pay off.
There are other pros and cons for the two types of home loans too, so it’s important to research those before you make a decision.
Refinancing and your loan term
Another aspect that’s important to understand is to do with the life of your home loan. Essentially, the longer the loan term, the more you pay in interest overall. So, if you are adding years to your loan term when you refinance, you may end up paying more with your new mortgage over time, even if your monthly repayments appear to shrink.
Don’t let this put you off – the potential savings you could gain through refinancing may well counterbalance the costs – just make sure you do the math first.
Our refinance calculator could help you work out if refinancing is worth your while.