With interest rates on the rise, home loan refinancing may create breathing room for your budget and repayments. But before taking the leap, understand your situation to ensure that refinancing can boost your pockets.
Here, we break down what home loan refinancing is, how it works and its advantages and disadvantages to help you decide.
What is home loan refinancing?
Home loan refinancing involves replacing your current mortgage with a new one. When you refinance, you can do it either with your existing lender or a different one.
Depending on your situation and goals, your new loan may have different terms and conditions compared to the previous one you took. For example, you may get a low rate, change your loan term from 30 years to 20 years, access loan features or switch between variable and fixed rates.
How does refinancing work?
Usually, banks and lenders reserve their lowest rates to new customers to attract them, so sticking to one lender can cause you to pay a loyalty tax. Loyalty tax is not a real tax, but it’s the cost you pay when your lender charges you higher home loan rates. That’s why refinancing with a different lender or a better deal that suits your current circumstance can help improve your financial position.
Refinancing involves paperwork and negotiations, which can be handled by your local broker, but the rewards you reap afterwards are worth the effort. The refinancing process can somewhat be like your home loan application.
Banks and lenders will likely check your proof of income, assets and liabilities to evaluate any changes to your financial situation. Along with your refinancing application, your lender may also order a property valuation to know the market value of your home. To know how much your property is worth, you can easily access leading data from our FREE property report.
If your application gets approved, your new lender will send your new contract. After signing, your old and new lenders will organise the payout for the old loan so that you can start making repayments on the new loan.
Different types of refinancing
There are two main types of refinancing:
1. Internal refinance
An internal refinance happens when you change to a different loan product with your existing lender.
2. External refinance
This type involves switching home loans with a different lender. This can happen when you find a better deal, lower rate or more flexible options from another lender.
Common reasons to refinance
Depending on your circumstance, there is a variety of reasons why you may want to refinance a home loan:
1. Get lower interest rates
Arguably the biggest reason why borrowers refinance is to get a better deal. The market is highly competitive, and interest rates always change. If you’ve been with your lender for many years, there’s a high chance that you’re paying more compared to new customers.
Refinancing to a lower rate either with your current lender or a new one will help you reduce your interest rate and repayments. This way, you find a rate that matches your situation, save more and avoid potential mortgage stress.
To estimate how much your repayments can change, use our home loan repayment calculator to know how much you can save at a lower rate.
2. Adjust your loan term
Similar to interest rates, life changes. Refinancing allows you to shorten or lengthen your loan. Let’s say you took out a 30-year mortgage at first, but your financial position improves, so you can now afford higher loan repayments.
You can refinance to shorten your term from 30 years to 20 years. From this, you can pay off your mortgage earlier, save on the interest you pay and own your home sooner.
On the flip side, you can also lengthen your loan if you have trouble with your budget. With this choice, you can lower your monthly payments to accommodate your situation, but you pay more in interest over the life of the loan.
3. Change loan types
Aside from changing your loan term, refinancing also allows you to switch between variable and fixed rate loans. For example, if you’re on a variable home loan and the RBA cash rate drops significantly, you can take advantage of the situation and refinance to a fixed rate loan. In this way, you lock in a lower home loan interest rate to avoid higher repayments in case of rate rises.
4. Tap into equity
If you currently own a property and want to access the equity you’ve built, this refinancing option (also called “cash-out refinance”) is for you. Equity is the difference between the market value of your property and your outstanding loan balance. For example, if your home is worth $800,000 and you have $500,000 remaining on the loan, your home equity is equal to $300,000.
But keep in mind that some banks and lenders will only let you borrow against your usable equity. Usable equity is calculated as 80% of your home’s current value minus your outstanding debt. Given the example above, your usable equity is $140,000.
Refinancing to tap into your equity will help you get cash for major expenses, such as renovations, big-ticket items, holidays or investments. That said, instead of taking out a new personal loan with a higher rate, tapping into your equity can be your alternative to save on your repayments.
5. Consolidate debts
If you struggle with managing numerous debts, then debt consolidation can help you streamline and budget your finance better. By consolidating your debts, you combine several high-interest loans (personal loans, credit card loans, etc.) into one with a lower rate, usually your home loan.
Aside from convenience, another benefit of debt consolidation is that it reduces your total monthly repayments since home loans have lower interest rates compared to personal loans.
However, as appealing as debt consolidation sounds, packing all your short-term debts into your home loan stretches your repayments. In turn, you may end up paying more in interest over the life of your loan.
6. Access loan features
Another reason why you may want to refinance your mortgage is to add more features to your loan.
- Repayment holiday: This allows you to pause your loan repayments in case of special circumstances, including a change of jobs, maternity leave, short-term injury or more.
- Offset account: An offset account acts as a savings account linked to your loan. The balance you deposit in this account is deducted from your loan, so you can save on the interest you pay. For instance, if your loan amount is $500,000, and you have $50,000 in your offset account, you only need to pay the interest on $450,000.
- Redraw facility: If you’ve made extra repayments on your loan, refinancing to access your redraw facility allows you to save on the interest you pay and withdraw any additional repayments you have made if you need cash flow.
- Flexible payments: You can switch between interest-only repayments and principal and interest repayments to suit your current financial situation.
- Loan portability: If you move from one home to another, loan portability allows you to take your current loan without arranging a new one.
7. End of a fixed rate
When your fixed rate home loan expires, you can refinance to avoid a higher revert rate. Depending on your goals, you can move to a variable rate or switch to a lender with a better deal.
How long does it take to refinance?
One of the dilemmas you may face when considering refinancing is the time and effort needed. The refinancing process depends on your situation and lender. So, if all goes smoothly, refinancing may take you a week, but it can go longer.
Internal refinancing can take a shorter length, but if you’re switching lenders, it may take a longer time to get approval.
Advantages and disadvantages of refinancing
Before refinancing your loan, knowing its pros and cons can help you avoid making hasty decisions you may regret in the end. Here, we list the advantages and disadvantages of refinancing to help you decide:
- Secure a better interest rate: Shopping around for a low rate can help you save more and reduce your monthly repayments and the interest you pay over the life of the loan. If your current lender charges you 5% on a $500,000 loan, you pay $2,923 monthly. If you switch your home loan to a lender with a 4.5% rate, your monthly repayments change to $2,780, which means you save $143 per month.
- Access loan features: Your current home loan may not have features that you can take advantage of. By refinancing, you may access more features, such as an offset account, redraw facility or split loans, which can help you save money.
- Decrease loan term: Many things can change over the life of your loan, so refinancing can help you choose and adjust to a term that allows you to cope with the changes. For example, if your income increases, you can shave off years from your loan to make higher repayments and pay off your loan early. On the other hand, a longer loan term can decrease your monthly repayments to meet your budget.
- Cashback offers: Aside from getting a better deal, refinancing can also help you earn money. Some banks and lenders offer generous refinance cashback offers as long as you meet certain criteria. For example, you can get up to $5,000 cashback when you refinance with It’s Simple Finance now.
- Break costs: One downside is the costs involved in refinancing. When you refinance before your fixed rate term expires, you may need to pay break costs to compensate for any profit loss that your lender may incur from your decision to break the loan contract.
- Fees: You may be subjected to fees and charges, such as discharge, application and valuation fees, when you take out a new home loan. The amount can vary per lender and your loan.
- LMI: If you have less than 20% equity in your home or your loan-to-value ratio (LVR) is greater than 80%, your lender may ask you to pay lenders’ mortgage insurance (LMI). This applies even if you already paid LMI when you first took out a loan.
Should you refinance your home loan?
Just like any financial decision, home loan refinancing is not a one-size-fits-all approach. Depending on your current circumstance, loan product and the market, you can either save more money or incur more costs.
For example, if you manage to fix your rate when the interest rates were low, it might not be a good time to refinance since it will be hard to find a lower rate. However, if you’re on a variable rate while interest rates are climbing, you can choose to refinance to a lower rate or fix your rate to have a sense of security and protection.
To make refinancing simpler, easier and faster, It’s Simple’s mortgage brokers can help you refinance with ease and comfort. Book your FREE expert consultation at your most convenient time to access the top 40+ banks and lenders in Australia that match your lifestyle and goals.