Should I refinance my home loan now?
Should you refinance your home loan now that interest rates are so low? The answer is probably yes, but here's what you need to know.
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Is now a good time to refinance your home loan? Well, for most borrowers it probably is. Interest rates have never been lower, and that could be the case for quite a while thanks to the economic downturn caused by the coronavirus pandemic.
But every borrower needs to look at their situation and make a choice that's right for them. Ask yourself the following questions before refinancing:
- How low is your current interest rate? Compare and see if you could be getting a better deal.
- Are you on a fixed rate? Do you want to fix?
- Do you own at least 20% of your property? If your equity is less than 20%, refinancing might be expensive.
Refinancing can seem confusing but it's really just a case of working out what your options are, finding a better deal and then applying for the new loan. To make it easier for you we've outlined the most common borrower scenarios below and given you some tips to make a better decision.
My interest rate is too high
This is the most straightforward case. If your interest rate is high, then switching to a better deal will save you a lot of money. Here's a quick example:
- Your current loan amount: $350,000
- Current interest rate: 3.45%
- Current monthly repayment: $1,561
- New interest rate: 2.59%
- New monthly repayment: $1,399
In this example, refinancing would save you $162 a month or $1,944 a year.
I want an offset account
Offset accounts are one of the most useful features on a mortgage. They allow you to save and spend money like an ordinary transaction account, but every dollar that sits in the account offsets your loan principal.
In other words, it makes your loan amount smaller and therefore means you pay less interest. Your monthly repayments usually stay the same, but you pay less interest and therefore repay the loan faster.
Offset account savings calculation
- You have a $400,000 home loan and it's your second year (30-year loan term)
- Your interest rate is 3.00%
- You have $15,000 in savings, which you add to the offset account
- Savings: You will pay $18,887 less in interest and finish your loan in 29 years and 1 month
If your current home loan lacks an offset account and you have some extra cash, refinancing to one that has an account could save you a lot in interest.
I want to lock in a low rate and forget about it
Fixed rates are very, very low right now. In many cases, they're even lower than variable rates (but this could change).
Now variable rates could drop further, of course. But if you find a great fixed rate deal and want to lock it in and not worry about looking at your repayments for a while, refinancing is not a bad idea.
Just be aware that once you fix, you're locked in. You can't take advantage of low variable rates until the fixed period ends. Well, you can, but there are break costs involved.
I'm currently on a fixed rate loan and want to break it
Let's say you're stuck on an older fixed rate loan that's now very high compared to better options on the market. You can refinance to a new, lower rate, but you need to check what the costs of breaking your fixed rate loan are first.
If these costs are high then they might outweigh the benefits of refinancing to a cheaper loan. Here's a quick example:
You have a three-year fixed rate loan with an interest rate of 4.12%. Your loan amount is $400,000. You are two years into your fixed rate and you want to switch to a 2.80% variable rate loan.
Switching would save you $294 a month, or $3,528 a year. However, you ask your current lender to calculate your breaking costs and they estimate it will cost you $4,800 (this varies due to many factors and this is just a hypothetical example).
This means that you'll end up paying $1,272 more just to break your loan. If you wait until your fixed period ends (or gets shorter) you could incur a smaller cost and get a bigger saving.
I want to access some extra cash
A lot of people refinance a home loan so that they can borrow a bit more money. They can use the money for investments, to fund a home renovation or to buy a car. With rates being so low, refinancing to a cheaper rate and borrowing a little more can be quite cost-effective. It will probably cost you less than taking out a separate car loan, for example.
And if you don't want to go through an entire refinance, you could also consider asking your current lender for a home loan top-up. This allows you to borrow a little more from your equity with your current lender and make your home loan slightly bigger.
I don't have much equity
Think carefully about refinancing if you don't own more than 20% of your property's current value. In other words, if you bought the property with a small deposit (say, 10%) and haven't been repaying the loan for long, refinancing could be expensive.
You probably already paid lenders mortgage insurance on your initial loan. If your equity is still below 20% then you may have to pay it again. That could cost you thousands.
And if property prices have fallen recently, your property could be worth less, making this even worse. Read our guide on refinancing in negative equity to learn more.
I'm struggling with mortgage repayments
It's very hard to refinance if you're in financial distress. This is because you need to apply for a new home loan with a new lender. The lender will examine your finances and your spending. If you've lost income or your debts have risen significantly, you might have your application rejected.
If you're in this situation, you're better off focusing on getting your debt, income and spending under control.
Still not sure if you should refinance? Talk to a mortgage broker
If you need some expert guidance on the refinancing question, especially if you're in a unique financial situation (or just a bit confused) then you can talk to a mortgage broker.
Chatting to a broker is free and they can guide you through the complexities of refinancing.
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