How to Refinance Home Loans
Refinance home loans are an option for existing borrowers. Any home loan is a long-term commitment and many factors can change over time to make refinancing a worthwhile option to consider. Borrowers should reassess their home loans whenever their own circumstances or interest rates change.
What is refinancing?
Refinancing a home loan involves a borrower taking out a new home loan to replace their existing one. The new loan may be with the same lender, or it may be with a different one. Borrowers can benefit from refinancing when their new loan’s terms and conditions are more favourable for their current circumstances than those of their existing home loan.
Should I refinance my home loan?
There are pros and cons of refinancing. Whether it is a good option depends on the borrower’s individual circumstances and lending market conditions. Below is an outline of situations where borrowers should (and should not) refinance.
Reasons to refinance
Borrowers can benefit in any of the following situations:
When the comparison interest rate on their existing home loan is no longer competitive.
For example, if a borrower takes out a fixed rate home loan for up to five years and variable interest rates drop significantly. Interest is the single biggest cost on any home loan. Even a small difference in interest rates can make a significant different to a borrower’s total repayments over the long term. However, home loans also have associated lender fees and charges. When comparing loans, it’s important to be aware that lenders typically quote two interest rates: nominal and comparison.
Borrowers should always use the comparison rate when comparing different products. The comparison rate includes both the cost of interest plus any associated fees and charges. The nominal rate on the other hand only reflects the interest charges. The comparison rate will therefore always be higher than the nominal rate, but it reflects the true cost of the loan. Under the National Credit Code in Australia, lenders are legally required to provide borrowers with the comparison interest rate on their products.
When they need significant additional financing.
For example, for a home renovation or an investment in another property. Borrowers should take the opportunity to explore their options for a refinanced home loan with the most favourable terms and conditions for their enhanced needs.
When consolidating high-interest debts.
Home loan interest rates are much lower than other forms of finance like credit cards and personal loans. A refinanced home loan gives borrowers the opportunity to consolidate all their debts into one low-interest loan. This makes repayments easier for the borrower to manage. Instead of making multiple payments on different debts, they can simply make their home loan repayment to cover all their debt. However, for a refinancing strategy to be a sound financial decision for consolidating debts, borrowers should adjust their repayments. If they don’t, they run the risk of transferring short-term debt (like credit card purchases) into long-term debt. Over the long run, they may actually pay more interest, despite the home loan interest rate being lower.
When there is a significant change in their financial circumstances.
Borrowers may have no option but to refinance if there is a significant change in their financial circumstances and they can no longer afford the repayments on their existing loan. In this situation, it may be possible for the borrower to refinance and lower their repayments (for example, by increasing the home loan term).
Reasons NOT to refinance
Borrowers are unlikely to benefit (and may even be financially worse off) if they refinance in any of the following circumstances:
When they have an existing fixed interest rate home loan and there are significant associated ‘break’ fees.
Lenders can charge ‘break’ fees if borrowers want to refinance a fixed interest rate home loan before the fixed interest rate period expires. If these fees are significant, they may offset any financial benefit of refinancing.
When their existing home loan balance is low, or they aren’t planning on owning the property for much longer.
There may be no significant financial benefit that can be gained in the short term. In addition, borrowers may find it difficult to gain approval for refinancing if:
- They have developed a bad credit history since they took out their existing home loan.
- They no longer have a stable source of income.
How much does it cost to refinance a home loan?
Refinance home loan costs vary depending on the lender. They can also vary depending on whether the borrower is refinancing with the same lender or with a different one. Borrowers should always remember that the home loan market is highly competitive, and that lender’s fees may be negotiable accordingly.
Examples of fees that may be involved with home loan refinancing include:
- Discharge fees. Lenders may charge an administration fee to prepare the documentation to terminate the existing home loan. However, since 2011 they can no longer legally charge early repayment/exit fees.
- Fees associated with the new loan, such as application fees and any ongoing charges. As mentioned earlier in this article, these additional charges must be included in the comparison interest rate.
What to consider before switching home loan providers
Borrowers need to understand their motive/s for wanting to refinance and do a thorough cost/benefit analysis of their options before making any decision. The benefits need to clearly outweigh the costs for the decision to be worthwhile.
Tax considerations when refinancing
Borrowers who refinance for an investment property can claim their refinancing costs as a tax deduction, such as any expenses associated with exiting their existing home loan and setting up their new one. They can then continue to claim their annual loan costs as tax deductions against any rental income generated by their refinanced investment property.
Owner-occupiers on the other hand cannot claim any tax deductions on either their existing or refinanced home loan.
The bottom line
Refinancing a home loan is a major financial decision. It is worthwhile for borrowers considering this option to seek professional advice based on their individual financial circumstances.
If you’re interested in refinancing your home loan book an appointment to speak with one of our home loan specialists. Or start to compare home loans online.