What does it mean to refinance?
Refinancing involves a borrower renegotiating their home loan. In practice, a refinance home loan usually sees a borrower move lenders for something more suited to their current needs.
As it is a new home loan facility, the borrower gets to renegotiate many aspects of their home loan with the new lender – provided they meet their assessment standards.
The lender gains a new customer by offering them something that the borrower feels is better suited to their goals and objectives.
Why do borrowers refinance home loans?
The reasons borrowers refinance a home loan are wide and varied. The consistent underlying reason is that something has made borrowers become aware that their current loan is not servicing their needs as well as it used to.
If you have not refinanced recently, you may be asking yourself, what am I missing out on? Many Australian borrowers are refinancing with activity in Jun 2022 being 17.8% higher than a year ago while over the same period new lending activity dropped by 2%.
Whether it’s a conversation with a friend about the interest rate they just got for their new home loan, or they are considering buying an investment, something will prompt a review of the current home loan.
When you refinance a home loan you are drawing a line in the sand between the loan you had and the new loan.
Your old loan suited you at the time it was arranged and for the foreseeable future.
The new refinance home loan will be chosen based on your current position as well as your future goals and objectives. Changes in circumstance are a major reason people consider a refinance home loan.
Many borrowers get comfortable with their home loan arrangement and let years pass by without revisiting it. Home loans is an area where loyalty does not often pay. It can pay to be alert, ask questions, and understand whether refinancing is worth it for you.
Here are some common reasons for a home loan refinance and their impact on the borrower’s finances.
Get a low home loan interest rate
Low home loan interest rates get most of the headlines. The reason for this is that interest is the single biggest cost of most home loans.
Many borrowers can get a lower rate when they move lenders. The cost savings can be significant. Here is an example of what an extra 0.50% discount can mean for a borrower making the minimum monthly principal repayments with the following loan features.
Any forecast interest savings will ignore fees, charges and changeover costs for this comparison.
A lower interest rate often results in lower required repayments. Using this example, minimum monthly repayments are reduced by $173.
In addition to have lower repayments, this illustration of a home loan refinance sees the borrower save a forecast estimate of $50,000 interest over the life of the loan.
The illustration is just that – an example only. Your unique circumstances, goals and objectives means a lower interest rate is just one of the outcomes that might come from refinancing.
51% of applications I did during 2020-22 were for a refinance. They make up a big part of mortgage brokers workload. I introduce borrowers to brokers here:
As for how impactful a lower interest rate can be, it will depend on what other terms are agreed with the new lender, some of which are outlined below. Remember, you get to renegotiate many aspects of your home loan.
Lower repayments
As the above example demonstrates, refinancing a home loan can reduce the required loan repayments. This frees up available cash to use elsewhere and is a common reason people move lenders.
Lower interest rates are one way of achieving lower repayments. There are other ways to lower your monthly repayment amounts, namely adjusting the loan term over which you agree to pay the loan back. These need to be considered in line with your goals and how they may impact the overall loan cost.
Lower repayments can see you with increased disposable income which can be useful when you have other priorities like:
- Spending money for education
- Saving for holidays
- Prioritising paying down other loans over this one
Lower “Life of Loan” interest cost
When you are changing lenders to refinance a home loan it is important you understand how some changes to your home loan affect how much home loan interest you pay over the life of the loan.
This could be a very significant amount and is certainly worth getting your head around. Understanding this concept can help prevent interest from silently eating away at your wealth over time.
Life of loan interest costs often get overlooked as the attractiveness of lower repayments is hard to see past.
Realising a better loan structure
Sometimes it is not until long after a loan has been established that you realise you could benefit from a more suitable loan structure. Or perhaps the loan structure did not exist at the time you took out your original home loan?
Property Share is an example of a loan structure that some borrowers wish they had set up at the outset. Property share allows multiple borrowers to get individual home loans for the one property purchase – like if two mates bought a property together.
Provided borrowers are eligible, a refinance home loan can move you into a more suitable loan arrangement.
Weighing up priorities
A good mortgage broker will be able to consider the impact of interest cost based on feedback on borrower priorities. The below priorities are typical considerations in many refinance scenarios and the borrower will need to consider the importance of each to their situation:
- Lower repayments per month
- Paying less interest over the entire loan term
- Accelerating loan repayments to reduce debt and interest costs
Consider the following illustration where I show an example that sees a lower interest rate and lower repayments—but it potentially costs the borrower much more over the long term.
This example is different to the last because the borrower did two things. In addition to reducing the rate the borrower also extended the loan term from 20 years to 25yrs. See what it does….
This refinance home loan sees a greater reduction in required monthly repayments – was $3,960 and now $3,335 per month. That is a reduction of $625 per month.
On the face of it, things look much improved with a lower rate and lower repayments.
But what about the impact of the loan term extension from 20yrs to 25yrs? This is illustrated below:
When you consider the potential interest costs over the life of the loan, the borrower will be out of pocket over $50,000 in interest costs compared to keeping the loan term the same as it was—even though they moved lenders for a lower interest rate.
Is this a big oversight? Maybe. Maybe not.
It depends on what the borrower is trying to achieve.
An arrangement like this can still be justified if the borrower’s brief was, for example, to have lower repayments to free up spare cash monthly to pay for education. The borrower just needs to be aware that in the long-term they might pay more overall unless they employ other repayment strategies to reduce the life of loan interest cost.
The interest cost over the life of the loan is more of a big—and very important picture—that often gives way to short-term priorities. It is an area of lending that can make a difference (one way or another) to the wealth position of a borrower.
See if it is worth it. I can introduce you to a licensed mortgage broker.
Lower ongoing fees
Ongoing home loan fees are not the same as charges stemming from interest rate calculations. Ongoing fees are regular and the same no matter what you owe the lender whereas Interest costs will decrease as your loan reduces.
Ongoing fees can take the form of annual package fees, loan account maintenance fees or offset account fees. Ongoing fees do not care what your rate is and what your loan amount is.
These fees made sense when the loan was established but as the loan reduces in size, fees can make up a larger proportional cost. The lower the loan amount, the more impact ongoing fees will have on the loan costs.
Investment strategy
Borrowers might refinance when considering an investment strategy. It could be an investment property strategy or perhaps another investment type, like shares or ETF’s. A borrower uses property equity when they borrow against the value of their property for a new loan or increase an existing loan. This type of investment lending strategy can be used by the borrower to make investments as opposed to using savings.
Accessing property equity will require a loan application and so presents an opportunity to assess the market for good investment home loan options. It is also a change in circumstance that might question suitability of any current home loans so it might be worth considering a refinance home loan.
Many Australian homeowners might have an investment property strategy that will one day see their existing home turn it into an investment property when they upgrade. This is a significant change in investment strategy so might warrant investigating if a refinance home loan is worth it.
Some investment property strategies see borrowers want to keep loans that are, or might one day, be useful to them – largely due to tax reasons.
In this case they are not so interested in paying them down as they are in preserving as much of the loan balance as makes financial sense.
They often use offset accounts to minimise the interest costs. Borrowers considering this type of investment property strategy should get tax advice and education as failure to understand it could result in avoidable extra interest costs.
These borrowers might periodically look to refinance their loan term back out to 30yrs with or without an interest only period.
Changing lenders by refinancing your home loan could be a way of renewing an interest only home loan payment strategy.
Interest only home loan repayments remain a popular investment property strategy for investors who wish to prioritise any spare funds towards other areas rather than paying off investment debt. For the interest only payment period borrowers only need to pay the fees and charges like interest. There is no requirement to reduce the principal debt amount during the interest only period.
Lenders will commonly allow five years (in some cases up to 10yrs) of interest only home loan payments as part of an overall 30yr loan term. If you wish to continue an interest only home loan beyond this period, there will come a time when you need consider a refinance home loan to reset your loan terms.
There are numerous items to weigh up for an interest only home loan strategy that I have outlined in a separate article.
I recommend borrowers seek financial and tax advice if they are before taking out a loan as part of an investment strategy.
Home loan refinance offers
Home loan refinance offers have been a popular way for lenders to attract borrows in recent years. Designed to help borrows overcome any inertia associated with moving lenders these incentives are designed to make any of the time spent and costs associated with switching lenders more palatable.
Home loan refinance offers come in many forms such as new TV’s, frequent flyer point offers and credit cards.
These home loan refinance offers are attractive but good mortgage brokers will ensure they are considered in the overall assessment of a home loan product for a borrower.
Refinance cash back offers
Refinance cash back offers motivate borrowers to move lenders by offering, you guessed it—cash money.
Originally designed to remove the obstacle that is the cost to refinance a home loan, refinance cash back offers have evolved in recent years to more than cover refinance costs. Many borrowers end up profiting in the short-term from moving lenders such is the appetite for lenders to attract new borrowers.
Refinance cash back offers can be very enticing but should not be the only reason for moving lenders.
Other home loan features
You might consider a refinance home loan if your circumstances have changed, and you wish to add features like an offset account.
On the other hand, you may find a basic home loan product with fewer features more suited to your ongoing needs. This might have the effect of lowering your ongoing fees.
Circumstances change as do lending products which makes it worthwhile making time to consider the suitability of both.
Building loans
I have discussed how a change in circumstances often brings about a refinance. Embarking on a new build or renovation project is a prime example of this. When it comes time to build on land you already own you do not need to stay with the lender you are currently with. The land loan will be considered as part of the refinance proposal when you seek construction finance.
Who can refinance a home loan?
Anyone who has a home loan is allowed to revisit their home loan. Your reasons for revisiting the suitability of your current loan can be many. A successful refinancing process will depend on whether you qualify based on current assessment standards.
Just as you needed to make an application apply for your current home loan, you will also need to apply for a refinance home loan. Given lending standards change and evolve from time-to-time lenders will take a fresh look at your overall proposal.
In assessing your eligibility for the new loan, a lender will review your proposal against their individual policies and requirements. This assessment will include, but may not be limited, to:
Equity in home
When you purchase your first home the conversation is, quite rightly, around how much deposit you need for a house. When you refinance your home loan it becomes more a question of how much property equity you have.
Property equity is the difference between your home loan limit and the value of your property. The bigger the difference the more equity you have.
20% equity is still considered the amount required to avoid risk insurance premiums (for most situations) like Lenders Mortgage Insurance.
Some lenders reward equity in home with lower rates. Provided other aspects of an application meet lending standards equity can be a significant lever in negotiating lower rates for your home loan refinance.
Income and expenses
Just as these were needed when you applied for you home loan, your serviceability will be reviewed again for an application to refinance.
Conduct and credit score
Conduct on any existing commitments – think credit cards, personal loans and even lender overdrafts. Are your repayments up to date?
Comprehensive credit reporting is the new credit report. Lenders who have signed up for this share very useful information via the comprehensive credit report when you make a loan application. It provides a window into your current, and past, credit behaviour.
The comprehensive credit report in Australia shows information such as credit application outcomes and repayment conduct on existing loans which enables the lenders to make an informed decision (sometimes without requesting any lender statements) when assessing an application for a home loan refinance.
Is refinancing a home loan worth it?
The only reason you should refinance your home loan is because it is worth it. Believe it or not it is not always about money. For example, convenience of lender branch access might be a borrower’s top priority.
So yes, look to see if refinancing it worth it—for you and no-one else.
Part of the analysis is to consider the costs of refinancing against the benefits you are looking for – some of which I have touched on.
Refinancing costs
It will cost money to change lenders, so these costs need to be factored into your overall benefit calculations.
There are fees to leave a lender like discharge fees and other administration costs. Depending on the type of home you currently have there could be early repayment adjustment fees.
There are also fees to start with a new lender like application fees and mortgage registration fees.
You need to be diligent and make enquiries to each lender or via your mortgage broker so any decision to refinance considers all costs to move lenders.
Do I need to change lenders to refinance?
The answer might surprise you but for many borrowers—No.
Refinance often refers to switching lenders but in essence you are just renegotiating the terms of your loan. You need to be proactive in approaching your existing lender to re-engage. It is not often they approach you with better offer.
Start with what you are trying to achieve. Is it just to lower your interest rate?
Start by asking your existing lender for a lower rate, then compare it to the other options on the market. You could end up saving yourself time by not having to move lenders.
Perhaps you would like to establish and new loan to invest in some shares with your spare property equity? Ask your existing lender for their terms. Will be they even consider it as part of their products on offer?
As you now know. Lenders are happy to pay refinance cash back offers to acquire new customers. Recent times have seen lenders try a lot harder to keep existing borrowers if they sense they might be looking into changing lenders. By engaging with your existing lender, you might get better terms, cash incentives or both.
How to refinance to a new lender
At a minimum there are three parties involved:
- Borrower(s)
- Existing Lender – on the way out
- New Lender – on the way in
Commonly borrowers will use a mortgage broker to represent them and provide various loan options based on the borrower’s needs.
Application
Any application for a refinance home loan will be based on the strength of your current financial position. Sure, your repayment conduct and performance is part of the assessment process, but having a home loan does not automatically qualify you for a refinance home loan.
Any refinance involves a full application just as was needed when you first applied for a home loan. The difference being is that time has marched on so an assessment may need to be performed again. The full financial assessment will include listening to your goals and objectives so appropriate loan options can be put forward to you.
Valuation
Given this is a new application the new lender will want to assess the value of your property. This can often prove beneficial if property values have increased. This might even place your overall application in a lower risk category and so gain access to lower rates.
If you are unsure of your home value there a some really useful free property estimate tools here.
Loan approval
Once the application has been approved and the loan offer accepted the borrower’s main tasks are done.
Switch lenders
The borrower provides consent for the two lenders (existing and new) to communicate and so enable the transition of the new home loans across to the new lender.
Final word
Refinancing a home loan can prove very beneficial. Provided the initial investigation is done thoroughly, borrowers will know prior to making any new home loan application, whether it is worth it—for their situation.
Sometimes borrowers get a pleasant surprise from their existing lender and are offered improved terms to stay. When it comes to refinancing home loans, it can be a case of nothing ventured nothing gained.
See if a refinance is worth it for you.
