If you’ve weighed up all the costs involved and decided refinancing your home loan is the best course of action, you’re well on your way to getting a better deal. But before you decide on a home loan you’ll want to make sure you don’t fall into any of the common refinancing traps.
Doing a bit of extra research and being a bit savvy can help you get the best deal possible on your refinance and maximise your home loan savings. Just make sure you keep an eye out for these common “refi” mistakes.
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Here are the six most common mistakes home loan refinancers make. Knowing these mistakes in advance can make all the difference.
If you’ve opted for a fixed rate loan, you’ve likely been attracted by a low advertised rate. A fixed rate, of course, offers you the peace of mind that your rate won’t move for the duration of the term you choose. What many people don’t know is that there’s nothing stopping this rate from moving after you initially apply.
Let’s explain. When you apply for a home loan, there’s a period of time from the day you’re approved to the day the home loan actually pays out for your property purchase or refinance. The stage at which the lender actually pays the funds for your home loan is called settlement. It can take as long as 90 days to get from application to settlement.
The problem with some fixed rates is that the rates a lender is offering can change between the time you first apply and the time your loan settles. In many cases, this means the rate you end up getting at settlement can be different from the advertised rate that convinced you to apply in the first place.
That’s a nasty surprise to face on the day your home loan settles.
Fortunately, many lenders offer a “rate lock” feature for their fixed rate home loans. This allows you to lock in the rate on offer at the time you applied, usually for up to 90 days. Some lenders charge a fee for this, but other lenders offer it as a free feature.
If you’re choosing a fixed rate home loan for your refinance, it’s definitely worth weighing up whether you should lock in your rate, and to compare the lenders offering rate lock guarantees.
When rates are dropping and you’ve worked out that you can get a better deal by refinancing, time can be of the essence. Unfortunately, human nature sometimes compels us to take a gamble. Call it home loan FOMO, or Fear of Missing Out, if you will.
Procrastinating on refinancing your home loan could see you miss out on some great offers. In a market where rates are dropping, it’s certainly tempting to wait and see if they fall a bit further before you make a move. But gambling on the bottom of the market is a risky proposition.
It helps to look at it this way: The goal behind refinancing is to get a better deal and save money and time on your home loan. If there’s a better deal out there now, it’s better to make a move than to gamble that there’s another one on the horizon. At the end of the day, you’re still coming out ahead.
You always want to make certain you’re getting the best deal available, of course. However, a real-life great deal today outweighs an entirely hypothetical one tomorrow.
When you refinance your home loan, it’s likely you’ll have the option to take out a new 30-year home loan term. Be very wary of doing this.
If you’ve been paying your home loan off for a few years, refinancing to a new 30-year term means you’ll extend the time it takes to be debt-free, and you’ll end up paying more in interest.
In some cases it might be necessary to add time onto your loan term. For instance, if you’re in financial hardship adding time to your home loan term could reduce your monthly repayments quite significantly and allow you to get back on track.
For example, let’s say you took out a $500,000 home loan at 4.50% for 30 years. After making repayments for five years, you’ll owe $455,789.59. If you refinance this amount to a new lender for a 25-year term at 4.00%, your monthly repayments would be $2,405.83. However, if you refinanced to a new 30-year term, your monthly repayments would drop to $2,176.01
But if you’re not in financial hardship, those lower monthly repayments might not be worth it in the long-run. Using our example above, refinancing your home loan to a 25-year term would see you pay $265,958.26 in interest. Extending that to 30 years means you’d end up paying $327,574.02. That’s a $61,615.76 difference. Suddenly, saving a bit of money on your monthly repayments seems a lot less attractive.
Most of the time when you refinance, you’ll find that your home has risen in value. This means you will have built up equity, and your loan-to-value ratio (LVR) will be lower than when you took out your initial home loan. This is a good position to be in.
With the way a lot of Australian property has performed over the last five or so years, you could be forgiven for assuming that property prices always go up. Unfortunately, that’s not necessarily the case, especially in the short term.
If you bought your house with a small deposit, it’s likely you paid lenders mortgage insurance (LMI). As we discussed in the last chapter, you generally have to pay LMI if you have less than a 20% deposit.
When you go to refinance your loan, your new lender will have a valuation done on your property. This is so they can assess the amount they’re willing to lend you, and determine your LVR.
If you’re fortunate and your house has risen in value, odds are your LVR will be much lower than when you initially took out your home loan, particularly if you’ve also been making repayments for awhile.
However, if your property has fallen in value, or even just remained the same, you could run into trouble.
If you had a small deposit when you bought your home and you haven’t been making repayments for very long, you may find your property hasn’t risen in value enough to get your equity up to 20% of the property’s value. This means that you could end up paying for LMI a second time.
As we discussed in the last chapter, the cost of LMI can be high enough to make refinancing unwise. If you had a high LVR home loan to begin with and your home has fallen in value, or hasn’t risen enough, you could get stung when it comes time to refinance.
Lenders often offer rock-bottom rates as a temporary incentive to entice borrowers. They may shave 15 or 20 basis points off their standard variable rate for a one or two-year period, after which the loan will revert to their standard variable rate.
These offers are commonly called introductory variable rates, or “honeymoon” rates. For a one- or two-year period, you’ll be guaranteed a steep discount. After that period ends and the honeymoon is over, all bets are off.
This doesn’t mean that introductory variable rate loans are a bad deal. On the contrary, they’re often great products. What it does mean is that if you’re refinancing to one of these products, you need to pay close attention to the rate you’ll revert to after the introductory period is over.
Rather than paying attention to the introductory rate, look at the lender’s current standard variable rate. If the lender you’re considering has a higher standard variable rate than the lender you’re currently with, it’s likely the deal you think you could be getting won’t add up to savings in the long-run.
A quick way to get an idea of the true value of an introductory rate home loan is to look at the comparison rate. A comparison rate takes into account the advertised interest rate along with fees and charges, and then expresses this as a percentage. For introductory rate home loans, the comparison rate also takes into account the rate the loan will revert to once the introductory period is over. If there’s a big gap between the advertised rate and the comparison rate, the home loan you’re considering might not be as good a deal as it seems.
That brings us to our final big refi mistake:
As mentioned above, the comparison rate is an important tool to give you an idea of a home loan’s real value. By taking fees and charges into account, a comparison rate is a much better reflection of a home loan’s cost than the rate you see advertised.
Now, the comparison rate isn’t a perfect tool. You can read the reasons for that here. But, it still gives an at-a-glance idea of the price you’ll actually pay for a home loan.
If you’re looking to refinance, pay attention to the comparison rates on offer. Also, have a look at the comparison rate for your current home loan. You’ll be able to find it in the Key Facts Sheet you would have been given when you applied for the home loan.
If a lender has a higher advertised comparison rate than you’re currently paying, you’ll likely want to keep looking for a better deal.
Summing it up
Even if refinancing is the best course of action, it’s important to do it wisely. With a bit of research and some attention to detail, you can avoid some of the common mistakes that could eat away at your refinancing savings.
Now that you know what to look for in refinancing a home loan, and what to avoid, in the next chapter we’ll explore the actual steps you need to take to refinance your home loan and start saving.
Check out the other parts in this guide
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