When you choose to refinance your existing home loan, you should take into account the amount of equity you’ve built up in your home. If your equity is less than 20% of the property's value then your new lender will charge you lenders mortgage insurance (LMI).
First up: What is equity?
When you make payments towards the principal amount of your home loan you build up equity in your home. The equity is the difference between your home's value and what you have left to repay on your loan.
This is the money you can expect to remain if you sell your home and repay your loan with the proceeds from the sale.
For example, if you live in a home worth $750,000 and you still have to repay $250,000, you have $500,000 in equity. The equation for equity is given below:
Equity = property value - outstanding loan amount
How much equity do I need when refinancing?
Many loans come with a maximum LVR of 95%, which means you cannot borrow more than 95% of the value of your home. What this also means is that if you wish to refinance you must have at least 5% equity in your home.
To put yourself in the best position to refinance, you should have at least 20% equity in your home.
Remember that lenders look at your equity as a means to assess risk. The more equity you have, the lower risk you present to the lender.
Finder survey: When did Australians last compare their home loan interest rate?
Response
In the last 6 months
29.14%
In the last year
17.45%
In the last month
17.27%
I don't have a home loan
14.39%
More than a year ago
13.85%
I've never compared my interest rate
7.91%
Source: Finder survey by Pure Profile of 1112 Australians, December 2023
What if I don't have at least 20% in equity?
When you choose to refinance without at least 20% equity in your home, there's a good chance you'll have to pay lenders mortgage insurance again. This is because you cannot transfer the existing LMI to the new loan, despite the fact that your previous lender is no longer at risk.
While getting a rebate when you terminate your LMI policy is possible, it’s crucial that you ask for it. Most LMI policies don't offer rebates if you've held your home loan for longer than 12 or 24 months. Even if you do get a rebate, this is usually not for the full amount. If you have to get LMI again, you could pay thousands.
Consider LMI costs in the following examples which use Finder's LMI calculator.
Home value
Equity
LVR
LMI cost
350,000
60,000
82.86%
$1,728
500,000
50,000
90%
$8,428
600,000
80,000
86.67%
$7,316
As you can see, the cost of LMI can be highly expensive which can outweigh the value of any savings you could net from switching lenders.
Calculate how a rate rise might affect your loan repayments
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Alternative options
Before comparing refinancing options, find out how much equity you have in your home. If you don’t have a 20% deposit saved but aren’t far off the mark, it might make sense to wait until you've built up a higher amount of equity. Check out this helpful guide to paying off your mortgage faster (and thus building equity).
Alternatively, you can consider applying for a guarantor home loan or applying with specialist banks that may have less stringent lending criteria for refinance mortgages.
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Richard Whitten is a money editor at Finder, and has been covering home loans, property and personal finance for 6+ years. He has written for Yahoo Finance, Money Magazine and Homely; and has appeared on various radio shows nationwide. He holds a Certificate IV in mortgage broking and finance (RG 206), a Tier 1 Generic Knowledge certification and a Tier 2 General Advice Deposit Products (RG 146) certification.
Refinancing your home loan can get you a better interest rate, adjust your loan term and take advantage of new features, but there are some things to look out for to make sure it's the right decision for you.
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