Refinancing Your Loan

Q: When should I refinance my mortgage?

A: Whenever it makes financial sense to do so

Heard about mortgage refinancing? In the past, most people who took out a mortgage doggedly continued with it until they had paid it off. These days, people refinance their mortgage much more frequently. The average duration of a home loan in Australia now is just 4-5 years. Here we look at some of the reasons people in Australia refinance their home loan.

NB: Refinancing does not always mean changing lenders. It may simply be a matter of rearranging or renegotiating your loans with your current lender.

Mortgage refinancing reasons: More competitive cost structure

The most common reason for people to refinance their mortgage is to get a better deal. But be careful you don’t become interest rate-fixated. When you refinance your home loan, you need to consider fees and charges as well as the interest rate. You often have to pay charges for exiting your current home loan, plus charges for taking out the new mortgage and some government fees to change the mortgage.

If your loan is more than 80% of the current value of your property you will have to pay Lenders Mortgage Insurance again on the new loan. This will impact significantly on the costs effectiveness of refinancing.

You need to be sure that in refinancing your home loan that you’ll be better off in the long run after taking into account all costs.

As a rule of thumb, you would want to be confident that you can recover the costs of refinancing in a reasonable period of time ie 6-9 months. If it takes you two years to recover the costs, it’s probably not worth it.

Mortgage refinancing reasons: more flexibility

Many people only discover the full details about their home or investment loan when it’s too late. They try to do something and get told by their lender that either they can’t do it, or they will incur a hefty charge if they do. An example is a redraw facility – the ability to pay extra money into a mortgage and then redraw it later. This feature is not possible with all home loans, or may have a large fee incurred each time you redraw so many people refinance their mortgage to give themselves this sort of increased flexibility.

Mortgage refinancing reasons: renovation

Depending on the size of the renovation and whether there are any structural changes to the property you may only need a simple increase to your current loan, or you may need a construction loan.

In either case it is worthwhile reviewing your loan at this point to make sure that it is still competitive and secondly that your current lender will allow you to complete the renovations you require. After all you will have to do a loan application even to get a simple increase with your current lender, so it makes sense to do a review at the same time.

Mortgage refinancing reasons: home equity

Over recent years in the property market houses have appreciated at a significant rate. e.g. a home you bought for $300,000 five years ago, might now be worth $500,000. Refinancing your mortgage with a home equity loan might let you tap into that extra $200,000 equity.’

This equity may be used for many purposes including buying an investment property, investing in the share market or other business opportunities. If you do decide to use your equity in one of these ways, make sure that you get the appropriate financial advice before proceeding. Generating equity can take a long time, losing it can sometimes be very quick if you make the wrong decision.

Mortgage refinancing reasons: defaulting

Some people find they have borrowed more than they can comfortably repay, and they’re in danger of defaulting. There’s no shame in that. But don’t suffer in silence. If you’re having trouble making your mortgage repayments, talk see about refinancing your home loan to make it more manageable.

Mortgage refinancing reasons: debt consolidation

This is a very specific type of refinancing/restructuring of peoples debts. There are two main reasons for debt consolidation. Both include absorbing debts such as credit cards, personal loan etc into the home loan;

1. Increasing household cashflow-In this case, the high interest debts such as credit cards and personal loans are refinanced into the home loan. The borrower then makes the minimum repayment required by the lender on their increased home loan. Whilst this can significantly increase a household’s cashflow, it comes at the expense of increasing the long term cost of those refinanced debts. It is a strategy to be used very carefully.
2. Paying off debts quicker using the lower interest rate of the home loan-In this scenario the high interest debts are refinanced into the home loan as above. The difference being that the household continues to make the same dollar amount of repayments as they were on their credit cards etc, but now they add them onto their normal their home loan repayments.

Using this technique the household gets the advantage of the lower home loan rate and can pay off their credit cards etc rapidly.

Mortgage refinancing reasons: divorce/property settlement

Unfortunately, not all reasons for refinancing are happy ones. In the case where a couple own property and are going through and divorce or property settlement, typically one party wants to retain the property and buy out the other party.

In scenario typically triggers a refinance or restructure of the loan as one current owner will now have to show that they can afford the loan as a single person. Sometimes this is possible, sometimes not. In the latter case, it will result in the property being sold and he proceeds divided amongst the parties.