As you read in our previous chapter, there are all kinds of benefits to refinancing your home loan. That being said, there are circumstances where you might be better off sticking it out with your current lender.
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Your fixed rate loan may have features that make you think twice about refinancing.
Your interest rate is locked in
A fixed rate home loan locks in your rate for a certain period of time, generally between one and five years. During this time, no matter what interest rates do, your rate will remain the same and your repayments won’t change.
This is great when variable rates are going up and you’re shielded from the increases. It’s not so great when they’re on their way down.
While it can definitely be frustrating watching rates plummet while you’re trapped in a fixed rate home loan that’s no longer competitive, refinancing might not be the answer. That’s because of fixed rate break costs.
Discharge fees and early termination fees
If you break a fixed rate home loan before the term is up, there are usually two fees you’re going to have to pay: a discharge fee and an early termination fee.
- A discharge fee is usually a couple of hundred dollars, so it shouldn’t set you back too much.
- An early termination fee? This is where it gets expensive.
When you signed a contract to fix your loan for a certain period, your lender calculated the fixed rate based on their own cost of funding. If their funding costs have dropped since you fixed your rate, the lender will lose money on your home loan if you break your contract early.
What this means is that if rates go down and you want to take advantage of it, your lender is going to end up losing money on your home loan.Now, you’d be hard-pressed to find lenders willing to happily take a loss on a loan they’ve made. Instead, lenders pass the cost onto you in the form of an early termination fee.
The way these fees are calculated is a bit complex. It has to do with the Bank Bill Swap Rate (BBSR), which is the bank’s cost of funding, and the amount of time left on your fixed rate. Your lender will look at the difference between the BBSR when you first took out your home loan and the current BBSR, and then multiply the percentage of that difference by the dollar amount of repayments you have left in your fixed term.
Is your head spinning? It does all sound a bit complicated, and for a detailed discussion of how break costs are calculated you can read this guide. The long and short of it, though, is that depending on how far rates have fallen and how much time is left on your fixed rate contract, your break costs could run into the tens of thousands.
This doesn’t mean it never makes sense to break a fixed rate loan. It just means you need to look at the math to decide if a lower rate is going to outweigh the break costs in the long-run.
The fixed rate break costs we talked about are definitely a strong disincentive to refinancing. The good news is that if you’re on a variable rate, there are no early termination fees. The Australian Government abolished them back in 2011 to make it easier for borrowers to switch home loans.But just because you may not have to pay an early termination fee, it doesn’t mean there’s no cost involved in switching your mortgage to a better one.
There are still a few fees you’ll have to pay both to exit your old home loan and to set up a new one. These fees can seriously eat into your refinancing savings, and if they’re too high they might make refinancing a no-go.
As we mentioned earlier, when you leave your current you’ll pay a discharge fee. This is generally the only cost associated with leaving a variable rate home loan, and it usually runs about $200.When you set up your new home loan, there are also a few fees you’ll have to look out for.
- Application fee. Many lenders charge an application fee. This covers the initial administrative cost of setting up your home loan account, and can run all the way up to $600, depending on the lender.
- A settlement fee. You’ll also most likely be charged a settlement fee. This covers the lender’s legal costs to fund your home loan. Settlement fees aren’t generally very high, usually running around $100. They can go all the way up to $300, though.
- Valuation fee. Before they decide how much to lend you, a lender will want to know your home’s current valuation. This means a professional valuer will be doing an assessment. This can run up to about $300.
- Lender Mortgage Insurance (LMI). If you had a small deposit when you first bought your home and you haven’t had your home loan for very long, you may also end up being charged LMI. This is an insurance policy that covers your lender in the event that you default on your home loan. You’ll end up paying LMI if you buy a home and have less than a 20% deposit. If you haven’t been repaying your home loan for very long, when you refinance you may find that the amount you’ve paid still doesn’t exceed 20% of the home’s value. If this is the case, it’s likely you’re going to have to pay LMI a second time, and this can cost you thousands of dollars.
- Stamp duty. Depending on your circumstances, you could even find yourself getting slugged for stamp duty. While most refinances are exempt from stamp duty, if you increase the amount of your home loan you might have to pay stamp duty on the difference between the original purchase price and the new home loan.
It’s fairly rare that you’ll have to pay stamp duty or LMI when you refinance, but the other fees we’ve discussed are pretty common. The good news is that some lenders will try to woo refinancers by paying some of these switching costs or waiving fees. If you do your research and compare home loans well, you could avoid a lot of the fees involved with refinancing.
A low rate is pretty enticing, but before you chase after a cheap home loan, you need to make sure it actually suits your needs.Some low-rate home loans can offer those rock-bottom interest rates because they skimp on features. That’s fine if all you want is a cheap, no-frills home loan, but if you want some flexibility with your mortgage a super-low rate might not be worth the sacrifice. Here are a couple of features you need to look into:
- Offset Accounts. One of the features that’s often missing from heavily discounted home loans is an offset account. Offset accounts are really handy features, which you’ll remember we discussed at length in the previous chapter. If you’ve been using an offset account wisely, you’ve been saving yourself a lot of money in interest. Switching to a low-rate home loan without an offset account could save you some money in the short-term, but it could also mean you no longer have the potential to shave years off your home loan by using an offset account.
- Flexibility. Another feature you could miss out on is the flexibility to make extra repayments. While nearly all variable rate home loans allow extra repayments, some fixed rate home loans don’t, or severely limit the amount you can make. If you’re switching from a variable rate to a fixed rate, you could lose this flexibility.
Just because a home loan lacks these features doesn’t make it a bad choice. You just have to weigh your goals and decide if a lower rate is worth the compromise on features and flexibility.
There’s more to a home loan provider than sharp rates or attractive features. If you need to communicate with your lender on a regular basis, you want to make it as pleasant an experience as possible. Good customer service might not be measurable in a dollar amount, but it can be priceless if you need to sort out a problem or ask a question.A lot of this comes down to personal preference. Many low-rate lenders either don’t have physical branches or have very few. If speaking to someone face-to-face is important to you, you might not want to refinance to a lender that won’t give you this opportunity.
This is one reason, some people prefer to keep most of their finance products together at the same institution. Some lenders may not offer products like transaction accounts, EFTPOS cards or credit cards. If you prefer the ease of having all your banking with the same provider, you might want to think twice before refinancing to a lender that doesn’t offer the services you want.
The good news is that if you’re unhappy with your current lender, there are still many lenders out there who will tick all these boxes. Just remember to research the lender you’re considering to make sure the level of service is up to your standards.
There are times when it might not make sense to refinance. Sometimes the costs can simply outweigh the benefits, and you’re better off sticking with your current lender. The good news is that you might still be able to get a better deal.
Lenders don’t want to lose your business. They have entire retention teams devoted to keeping you as a customer. If you call your current lender and tell them you’re unhappy, they might offer you a better rate to keep you from leaving.
In most cases, though, refinancing to a better rate is going to see you come out ahead in the long-run. But when you do refinance, you have to make sure you do it shrewdly. In the next chapter we’ll talk through some of the common refinancing traps people fall into, and how you can avoid them.
Check out the other parts in this guide
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