The home loan market is incredibly competitive. There are a lot of lenders out there vying for your business, and they’re all trying to outdo each other with the best interest rates, the cheapest home loans, the lowest fees or the best features.
The great news is that this puts you in an ideal position as a borrower. If you don’t think you’re getting the best deal out there, you could potentially save thousands by refinancing. But before you do, you’ll need to know the ins and outs of the process, as well as be able to weigh up whether it’s the right time to make a switch.
Our definitive guide will answer your questions and walk you through the steps to help make sure you get the best deal possible on your home loan. With so much competition, there’s no reason to keep paying too much.
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While refinancing is usually a pretty straightforward process, it is admittedly going to take a bit of work on your part. So before you decide to jump in with both feet, it’s good to weigh up the benefits you’re likely to see.
What are the benefits of refinancing? Well, that depends on your situation. But the benefits can be pretty significant.
This is the most common reason why people refinance. They’re looking for a cheaper home loan. A “cheaper” home loan generally means a loan with a lower interest rate, fewer fees or, ideally, both.
It’s hard to overstate the benefit of shaving a few basis points off your home loan rate. It can save you literally tens of thousands of dollars over the life of your loan. Let’s look at a quick example.
Suppose you had a $500,000 home loan at 5.00%. Your monthly repayments would be $2,685, and over the life of a 30-year loan you’d be paying $966,278.92.
Now suppose instead your home loan rate was just 10 basis points cheaper, at 4.90%. Your monthly repayment would now be $2,653. Sure, that $32 a month doesn’t sound like a huge saving, but when you look at it over a 30-year term, you’d be paying a total of $955,308.10. That’s $10,970.82. That extra $32 really adds up.
Of course, if you’re refinancing it’s likely you’ve already been paying your home loan for a little while, and you won’t have 30 years left on your home loan term. There are still some serious savings to be made by refinancing.
Let’s say you’ve been paying your $500,000 home loan for five years, and you’ve got around $460,000 remaining on it. If you’re on a 5% rate paying $2,685 per month and refinance that $450,000 to a 4.90% rate at a new 30-year term, your monthly repayment would drop all the way to $2,441.34.
Now, there’s one problem with this scenario: while your repayments would drop significantly, the extra five years you’d add to your loan term would mean you end up paying more in interest in the long-run. How much more? Let’s have a look.
In our first example, you’ve been paying your 30-year home loan at 5% for five years. You’ve paid it down to $460,000, and with interest, the remaining 25 years of your loan term would cost you a total of $805,232.43. In other words, $345,232.43 in interest.
If you refinanced that remaining $460,000 to a 4.90% rate and a new 30-year term, over the life of the loan you’d end up paying $878,883.45, or $418.883.45 in interest. The cheaper repayment has ended up costing you dearly.
So let’s say instead you keep yourself on track to pay your loan off in the original timeframe. You refinance that $460,000 at 4.90% for a 25-year term. Here’s where you actually start to see the savings. Now you’ll pay a total of $798,714.48, or $338,714.48 in interest. You’ve saved yourself $6,517.95.
When you're making interest payments, the old adage is true: time is money. To save yourself time on your home loan, you can refinance to a lower rate but keep your regular repayments the same. This takes a bit of discipline, of course, but it can result in some serious savings.
If you’ve budgeted well and you’re comfortable with your home loan repayment at its current level, refinancing to save time on your home loan makes good sense. The more time you’re able to shave off, the more the savings will add up.
Let’s say in our hypothetical example that you’re five years into your 30-year, 5% home loan. You’re paying $2,685 a month, and you’ve got $460,000 left to pay off.
Now, suppose you refinanced to a sharp rate of 3.95% – certainly feasible in today’s home loan market – and you kept your monthly repayments steady at $2,685.
Your new rate would cut an amazing 4.1 years off your home loan term. Not only would it see you ridding yourself of home loan debt earlier, but you’d also save an incredible $144,700 as a result.
As you can see, if you can manage to keep up your current repayments while getting a better deal on your home loan, you can maximise your savings by minimising the number of years it takes to pay your mortgage.
Equity is the difference between the amount you owe on your home and its value. In the example above, if you took out a $500,000 home loan and owed $460,000, at a glance it would appear you have $40,000 in equity. However, this oversimplified view overlooks both the amount you actually paid for your home and the amount it’s grown in value since you bought it.
Over time, your home is likely to increase in value. Of course the property market can go through peaks and troughs, and it’s entirely possible for your home to lose value, but the predominant trend is for property values to increase over time.
With this in mind, let’s take another look at the example above. In our scenario, you originally took out a loan for $500,000. Assuming you had a 20% deposit when you bought your home, that would mean you purchased it for around $625,000. So, even ignoring any capital growth, once you’ve been paying your $500,000 for five years, you’ve built up $165,000 in equity.
Now, let’s assume your home’s value has grown at the cumulative capital city growth rate over the last five years, which CoreLogic puts at 47.3%. That would put your $625,000 home’s value up to $920,625. All of a sudden that $165,000 in equity has transformed into $460,625.
How can I refinance to unlock equity?
When you’re refinancing, a bank will typically assess your current loan-to-value ratio (LVR) by looking at the value of your home minus what you owe on it. It will then generally lend enough to bring your total LVR up to 80%.
For example, in our hypothetical situation above, you would have built up $460,625 worth of equity. This means your current LVR is just over 50%. Given that most lenders will refinance your home loan up to 80% of its current value, this mean you would be able to borrow another 30%.
$920,625 x 0.30 = $276,187.50.
Why would I refinance to unlock equity?
One of the most common reasons to unlock equity is to use it to invest. This could mean investing in any number of asset classes, including property.
If you were the owner-occupier in the situation above and you refinanced your home loan to unlock nearly $277,000 of equity, you now have a healthy deposit to purchase an investment property. Or, you could choose to invest in another asset class such as shares. If it’s likely that the asset you invest in will generate higher returns than the interest you pay on the amount you borrow, it could be a savvy move to refinance in order to unlock equity.
Alternatively, you could choose to use your equity to renovate your home. A well-planned renovation could add value to your home that outweighs the expense of accessing your equity.
Refinancing to unlock equity in order to invest could also deliver tax benefits. If you choose to invest in assets such as an investment property or shares, you could take advantage of negative gearing concessions. Moreover, if you choose to invest in property you can deduct the interest on your home loan repayments.
If you choose to use your equity to renovate, you may be able to claim depreciation benefits on the improvements you make. Regardless of which path you choose, it might be wise to speak to a financial adviser or tax professional to sort through your options.
If you have a bad credit home loan
If your original home loan was a specialist loan for people with bad credit, odds are you’re paying a very high rate. If you’ve been in your current specialist home loan for a few years and you’ve kept up with your repayments, you may be able to refinance into a traditional home loan for a much lower rate.
If you want to refinance out of a bad credit home loan, there are usually a few stipulations:
- You have to have paid any defaults, and they must no longer appear on your credit file.
- You need to have been regularly making your repayments on time for the last six months.
- And you generally need to have built up enough equity in your home to owe 80% or less of the property’s value.
Bad credit home loans are not meant to be permanent solutions. Rather, they’re meant to help you get yourself back on track after a rough patch. If you’ve been diligent in managing your finances and you’ve been in your bad credit home loan for some time, it could be time to refinance.
If you want to consolidate your debt
Some borrowers might find themselves in a situation where they’re comfortable with their home loan repayments, but are finding it a struggle to manage their other debts. One of the benefits of home loans is that they charge a very low interest rate in comparison to other forms of debt. This is where refinancing for debt consolidation could be a savvy move.
For example, if you have a number of credit cards and personal loans charging interest at rates of anywhere from 15–25%, imagine the potential savings you could see if you refinanced that debt onto your home loan at a rate of 4%.
In addition to being charged a much lower interest rate, refinancing to consolidate debt means all your debts are combined into a single repayment. You won’t find yourself juggling a number of bills, and you won’t get hit with fees for all your separate debt facilities.
The one caveat is that consolidating things like credit card debt and personal loans into your home loan may give you a lower interest rate, but it could also lengthen your loan term. Instead of paying off your credit card or personal loan over the span of a few years, that debt will now be stretched out over 30 years. This could see you pay more interest in the long run.
If you’re in arrears
Being in arrears means that you’ve fallen behind on your home loan repayments. This is a serious situation that, if left unresolved, could see you lose your home.
If you find yourself in arrears on your home loan, the first thing to do is talk to your current lender to set up a plan to get you back on track. One option you might be able to explore is refinancing.
Sometimes your current lender will be happy to alter the terms of your home loan to get your repayments back on schedule. This could mean giving you a repayment holiday so you can get back on your feet, or it could mean lengthening the term of your home loan to decrease the repayments.
If your lender isn’t willing to work with you, or if the solutions they’re offering don’t seem likely to be enough, there are lenders out there willing to refinance a home loan that’s in arrears.
Usually, this will mean going with a specialist lender. The bad news is that you’re probably going to be charged a higher rate. The good news is that it could help you keep your home in extreme circumstances that could have otherwise led to foreclosure.
And there’s more good news.
As mentioned above, most specialist home loans aren’t meant to be a permanent situation. They’re meant as a temporary solution to help you through a rough patch. While you might pay a higher rate for a few years, you should eventually be able to refinance again once you’ve gotten your repayments back under control. And paying a higher rate for a couple of years is almost always preferable to losing your home.
Price isn’t the only factor that differentiates home loans. While many of us only pay attention to the interest rate when we’re comparing our options, it can be just as important to look at the features available on different home loans.
The right features could give you added flexibility, help you pay your home loan off faster or streamline your banking products. If your home loan doesn’t have features that help you take charge of your finances, it could be time to think about refinancing.
An offset account is a handy feature that enables you to minimise the amount of interest you’re charged on your loan, and potentially pay it off much faster.
Here’s how it works:
An offset account is a transaction account that’s linked to your home loan. When interest is calculated on your home loan, your lender subtracts the amount that’s in your offset account.
In other words, if you have a $400,000 home loan but have $50,000 sitting in an offset account, your lender will only calculate interest on $350,000. It means more of your regular repayment will go toward paying down your principal, or the original amount you borrowed, and you’ll pay your home loan off faster as a result. And as we’ve already explained, when it comes to paying down interest-accruing debt, time is serious money.
Because it’s a transaction account, you have access to your funds at any time. But the longer you leave funds in your offset account, the more you’ll save in interest.
If your home loan doesn’t have an offset account, it could be time to refinance to one that does so you can save on interest and potentially pay your home loan off faster.
Making extra repayments, even if they’re small amounts, can add up to serious savings over the life of your loan. Let’s look at an example:
If you have a $500,000 home loan at 4% interest over a 30-year term, you’ll be making monthly repayments of $2,387.08. The total amount you’d pay over the life of the loan would be $859,347.53.
Now let’s say that after the first year of your home loan, you started kicking in an extra $100 every month.
This might not seem like much, but over the life of a 30-year loan it really adds up. This is because any additional repayments you make are applied to the principal rather than interest.
Over a 30-year term, that extra $100 from year two onwards would amount to a saving of $28,099.95 and knock two years and one month off your home loan.
While most variable rate home loans will allow additional repayments, it’s worth checking whether or not yours does. If it doesn’t, it might be time to refinance.
Some home loans offer you the ability to bundle a number of banking products together for a single fee. Rather than pay separate fees for your home loan, transaction accounts and credit cards, you can combine all your products for one annual fee. These are usually known as package loans.
Package loans generally also offer discounts on a lender’s home loan interest rates, and these discounts can be substantial enough to dramatically outweigh the amount you’ll end up paying in fees. Some even offer discounts on insurance premiums and financial advisory services.
If you have a number of banking products charging you separate fees, refinancing to a package deal could get you a cheaper interest rate and save you money on fees.
You might choose to refinance for one or several of the reasons above. Refinancing can give you better flexibility, help you get your finances in order or save you tens of thousands of dollars over the life of your loan.
But, there are some situations where refinancing might not be such a great idea. In the next chapter, we’ll talk about some of the disadvantages associated with refinancing your home loan.
Check out the other parts in this guide
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