How to refinance your home loan.

On 3rd November 2020, the Reserve Bank of Australia made a momentous decision, cutting the official cash rate to 0.1%, the lowest it has ever been. The impact of this change caused some borrowers to call their lenders and ask for a better interest rate, others opted to refinance their loans with other lenders, and some opted to do nothing.

If you’re one of the many people considering refinancing, we’ve listed some key consideration to keep in mind to help you make an informed and beneficial decision.

1. Consider if refinancing your home loan is a viable option for you.

The key reason to refinance is to find a home loan that better suits your circumstances or that can save you some money. So, it’s important to consider the cost of refinancing before acting, to ensure that it’s a better option for you. The number of cashback offers in the market at the moment is further complicating this decision.

Comparison rates, which include interest and fees for the life of the loan, are a useful way of comparing different lenders.

Some of the common costs to keep in mind include:

• Break fees. If you have a fixed rate home loan, a break cost may be payable if you switch your loan or repay your loan early. This fee compensates the lender for any losses, including administration and wholesale borrowing costs, they incur from someone breaking their fixed rate home loan contract. Break fees vary, as they’re calculated according to the conditions of each loan.
  
  
• Mortgage Application fee. This is also known as an establishment fee. Lenders may charge a one-off application fee to set up the refinanced loan and cover administration costs, this can range from $0 up to $1000.
  
  
• Valuation fee. A new lender may require that a valuation be completed before you can refinance your loan with them. The purpose of the valuation is to assess the current market value of your home. The valuation fee may be waived, and if payable it will vary from lender to lender and can be as much as $600.
  
  
• Discharge fee. This is also known as a settlement fee and is payable when a borrower finishes paying off the balance on a loan and requests release of the mortgage, or refinances to another lender. The fee can range from $150 to $400.
  
  
• Lenders Mortgage Insurance (LMI). If you’ve less than 20% equity in your property, a lender may require you to purchase LMI to cover them in the event you’re unable to repay your loan. Learn more about LMI in this video: What is Lenders Mortgage Insurance?
  
  
• Annual fee. Some lenders may charge an annual fee for the lifetime of the loan. Other lenders may waive these annual fees as part of a special offer.

2. Be clear on what you want to achieve by refinancing your loan.

There are many reasons to refinance. Perhaps you’re looking to take advantage of an improved deal, a lower rate, more flexible features, to use the equity in your home to renovate or invest, or to consolidate your debt. Before acting, it’s important to understand the reasons to refinance in more detail.

• A lower interest rate. By refinancing your loan at a lower interest rate, you reduce the amount of interest you pay over the life of your loan.
  For example, using the Westpac Mortgage Repayment calculator, you can see in the table below that a .5% reduction in rate  equates to a $132 lower monthly repayment and a saving of approximately $47,000 in interest over the life of the loan. (Assuming that the interest rate doesn’t change, and minimum monthly repayments are made on time for the term of the loan.)

Remember that:

• • Variable interest rates may change, so you may end up paying a higher rate.
  • There may be break costs payable if you switch your fixed loan or repay your fixed loan early.

• Using equity in your property to fund renovations. Equity is the portion of your property’s value that you own outright. It’s essentially the difference between how much your home is worth and what you owe on your home loan. Building up equity in your property, either by repaying your home loan or increases in the property value, is helpful for refinancing if you’re looking to borrow for renovations.
  
  Example: Let’s say you have a property worth $600,000 and you’ve got $300,000 owing on a home loan. Once the lender applies their loan to value ratio (LVR) of 80% to the property value, then you can potentially borrow an additional $180,000 against the current market value to fund further improvements to the property

Remember though:

• • borrowing more money means your home loan may take longer to pay off, cost you more in total interest charges and repayments.
  • while you may want to access the equity, you’ll still need to be able to demonstrate that you can afford the increased loan repayments.

• Your fixed rate period is expiring. The end of the fixed term represents an opportunity to review your personal and financial circumstances and decide on the best way forward for you, whether that be staying with your current lender or refinancing. In most fixed home loan agreements, at the end of the fixed rate period, your loan will revert to a variable rate or you’ll have the option to lock in all or some of your loan to another fixed rate within a certain period of time eg 14 days without incurring additional fees.

• You’re paying off other debts and you want to simplify your finances. Having multiple debts is not unusual as the borrowings are often for different purposes. However, it can be more difficult to keep up with multiple repayments. If you want to simplify your finances, you may consider debt consolidation when refinancing, especially if you can do so at a lower interest rate. While it may be tempting to roll all your debts into a home loan to take advantage of a lower interest rate, this potentially means that you may be paying off short term loans, such as a personal loan, over a much longer period meaning that it will cost you more in the long run. If you are looking to reduce your repayments and simplify your finances by having it all in one low-cost place, consider making more than the minimum repayments on the new loan in line with what you would possibly be paying on a shorter term loan to reduce your long term interest costs.
  
  If you’re struggling with loan repayments and need help, Westpac Assist can provide financial hardship support for Westpac customers. Also you can use the National Debt Helpline, on 1800 007 007, to find a financial counsellor in your area or for information and support.

• Funding investments. Refinancing may also be an opportunity to access equity in your home to borrow money to invest in shares or even to buy an investment property. It’s important to seek appropriate financial and taxation advice tailored to your personal circumstances before pursuing this option so you’re clear on the risks involved. The major risks of borrowing to invest include:
  • Larger losses as borrowing still needs to be repaid even if the investment doesn’t perform.
  • If borrowing on a variable rate, the interest rate and repayments can increase.

3. Negotiate with your current lender before refinancing to a new lender.

For many people, the objective of refinancing is to find another home loan with a lower interest rate or repayments. Whatever your reason for considering refinancing, a recommended first step is to speak to your current lender and ask if they have a more competitive option for you. This may include discounted interest rates, waived fees, or even other options like access to an offset account or redraw capability.

Remember:

• negotiating a reduction in interest rate for the same loan with your existing lender will not affect your credit score as it will not require a credit check.
• if your lender’s credit policy has changed, for example they have introduced tighter criteria for debt servicing, this may affect your ability to refinance your total existing debt.

4. Understand the effect your credit score may have on your ability to refinance.

For any new home loan application, lenders typically check your credit score using information provided by credit reporting agencies. This score is based on several factors, including the amount and types of credit you have used previously, who it was from, and how consistently you repaid it. Your credit score gives them an indication of how likely you are to repay a new loan so it’s very important to your application. You can find out more about credit scores in this video.

A low credit score may work against your efforts to refinance. Conversely a high credit score is likely to support your application to refinance your home loan. It’s worth checking your credit score before applying to refinance. You can request a free copy of your credit report once a year from the credit reporting bodies Equifax, illion and Experian.

Remember:

• Multiple credit enquiries can have a negative effect on your credit score. If you’re trying to refinance and are declined and subsequently apply with another lender, it’s likely that your credit score will fall. So, it’s worth considering and selecting the lender whose products best suits your circumstances and whose lending criteria you’re most likely to meet. To ascertain this, a mortgage broker may be able to provide guidance.

5. Check your ability to make the new mortgage repayments comfortably.

Your debt-to-income ratio (DTI) is a way some banks may measure your ability to make mortgage repayments. DTI is the amount of your total debts (including other loans, credit card and overdraft limits) divided by your annual gross income (before tax). It enables lenders to determine the likelihood that you can afford to repay a loan.

For example, for a couple earning an annual combined gross income of $150,000, who want to refinance their loan and borrow $600,000 and who have a credit card with a limit of $15,000, their DTI is calculated as:

New loan of $600,000 + Credit card $15,000 =Total debt of $615,000

$615,000 ÷ $150,000 = 4.1 DTI

In other words, for every dollar of income, this couple wants to borrow $4.10.

The lower your DTI the more attractive you’re likely to be as a borrower. A few tips that may help you to lower your DTI:

• Reduce unused debt facilities. For example, if you have a $15,000 credit card limit but rarely use this amount, consider reducing it in line with your usual usage.
• Increase the amount you repay to reduce your debt more quickly.
• Avoid taking on more debt by delaying purchases or saving for them instead.

6. Understand the refinancing process.

Whatever your reason for refinancing, it’s good to know where to start and what steps to follow.

 Step 1: Figure out how much you want to borrow.

The amount you borrow should include the amount you need to repay your current loan plus any additional money needed for renovations, debt consolidations or other expenses. By checking out your paper or online account statements, you can remind yourself what your loan amount outstanding is, find out what you’re repaying, and how often you pay it.

Step 2: Look around to make an informed decision.

 Look around at the rates and specials offered by different lenders and compare them with your current loan(s). If you don’t have the time to approach lenders directly, talking through your options with a broker is another way to better understand the options available to you.  There may be a situation where you’ll be better off staying with your current lender. For example, breaking a fixed rate loan to save 10 basis point (0.10%) may not be worth the switch, given the costs involved.

Step 3: Select your loan structure.

If you’re undecided whether  the flexibility of a variable rate, which may also come with an redraw facility or  offset account, or the certainty of a fixed rate would suit you better, you could opt to split your loan. With this your home loan is divided into two smaller loans accounts – one fixed and the other variable – providing you with both flexibility and certainty.

Step 4: Make your application.

You’ll need to provide the lender with documentation to support your loan application including personal information, proof of your income, details of your current loan, details of your property together with information on your earnings, expenses, assets and what you owe in other loans. After receiving this information, the lender will seek your permission to conduct a credit check.

Step 5: Be approved.

When your new loan is approved, your new lender will supply your new loan documentation. You should ensure you understand the terms and conditions in the loan agreement and it’s advisable to seek independent legal advice before signing them.

Step 6: Transferring the mortgage.

When all the documentation is signed, your new lender will usually arrange paying out your previous lender and transfer the mortgage. After settlement you should receive a welcome pack from your new lender, which will set out the interest rate and repayment terms again.

In summary, if you’re thinking about refinancing be very clear about your reasons for doing so, what you’re looking to achieve, and take the time to do your research to ensure the switch will be beneficial. You can find out more in this Davidson Institute article on the Westpac website.

This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness for the information to your own circumstances and, if necessary, seek appropriate professional advice. ©Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714.