The hidden costs of refinancing your home loan
Refinancing the mortgage can come with hidden costs. Here's what to watch out for.
Australians owe an average of $388,000 on their home loan, and with that sort of debt to manage it doesn't pay to take a set-and-forget approach.
The good news is that lenders are hungry for new business.
In fact, many of the best home loan deals are reserved for new customers, and it can make switching to a new home loan a smart financial move. It turns out plenty of people are doing just that, with around 17,000 mortgages refinanced each month across the country.
It makes refinancing part of today's home loan landscape.
"Moving to a new financial institution is easier than ever," says Simon Charters, regional sales manager with Greater Bank, winner of Money's 2018 Home Lender of the Year award.
He says it's a good idea to review your home loan every two years to be sure you've got the one that's right for you at the best possible rate. Any major shift in your personal or financial circumstances should also trigger an evaluation.
"This doesn't mean you will automatically refinance each time," says Charters. "It allows you to determine whether a change in loan will help you achieve your financial goals."
That said, Whitlam Malkoun, a Melbourne-based senior broker with Aussie Home Loans, says one of the most common triggers for refinancing boils down to the mention of interest rates in the media.
"It gets people thinking about the rate they're paying on their own loan," he says.
While homeowners are already embracing opportunities to save on their loan rate, Charters believes this will become more important when interest rates eventually rise.
With the Reserve Bank having flagged that the next rate move is likely to be up rather than down, it's worth understanding what's involved in refinancing.
The chance to cut interest costs may be a strong motivator but it's not the only reason to consider switching. Charters says he's often asked about ways to access home equity.
"Many customers choose to refinance to use their equity to fund major purchases such as renovations or extensions, or even go on a family holiday."
Refinancing can also be a way of freeing up low-cost funds to invest in a rental property or shares.
In addition, refinancing can be a possible strategy for debt consolidation, says Charters. Folding credit card balances and personal loans into your mortgage means managing just one monthly payment. And because home loans often come with the lowest rate across all types of credit, consolidating debt this way has the potential to trim your total monthly repayments.
How to handle the paperwork
On the face of it, refinancing can seem like a complex process. But it shouldn't be.
The inevitable paperwork can be a small price to pay in return for what may be valuable savings, and a sensible starting point is to know the interest rate you're paying on your current home loan.
HSBC research indicates that one in four homeowners don't know this figure, yet it's the main benchmark that shows if a new loan will help you save. If you're unsure what your home loan rate is, take a look at your latest mortgage statement or contact your lender or mortgage broker.
Follow this up with research to confirm that a new loan is the right move. Look online or, better still, talk to lenders or a mortgage broker. Malkoun says refinancing is a major step that "calls for personal interaction".
For the best possible deal, be prepared to cast your net wide. Many smaller lenders offer excellent value on home loans without scrimping on features. And, as tempting as it may be, avoid focusing solely on interest rates.
Malkoun acknowledges that most people refinance to save money but, "don't worry about the rate - worry about the product", he cautions. "Refinancing should be about having the home loan that ticks all the boxes for your needs, both in terms of rate and features. If the home loan features are used correctly they can help you save big dollars."
Greater Bank's Charters agrees. "Consider the features that will assist your financial situation, such as flexible repayments options, variable or fixed rates, redraw facility or offset accounts."
Having identified the loan that suits your needs, what follows is the application process. This should be similar to when you took out your current loan. "Lenders will require information and supporting documents such as identification, bank statements, pay slips and/or tax returns to assess whether you can afford the new loan repayments," says Charters.
Remember, too, your new mortgage will be secured by your home, so the new lender may want to value your property to determine how much it's worth.
"If the lender approves your loan application, you will receive a formal loan offer to sign and return," says Charters. "The new lender then submits a discharge form to your current lender. Settlement will occur, and your new mortgage is used to pay off your old mortgage." At this point you simply start making repayments on the new loan.
It all sounds easy enough - and it can be. Don't simply assume, though, that refinancing will save you money. Malkoun says it pays to be "quite sure about how much you have to spend in order to save money on your home loan. In many cases, a very small rate difference won't produce valuable savings once you've taken the cost of refinancing into account."
Indeed, the cost of refinancing can pose the biggest pitfalls for unwary homeowners.
Some refinancing costs are set in stone - such as the discharge fee on your old loan. This is essentially an administration charge that usually comes to around $350, sometimes less. Application fees on the new loan can be more flexible, and you may be able to negotiate your way out of the cost. "In a competitive market, lenders will often waive the application fee on a new standard variable rate home loan," says Malkoun.
Be aware that your new lender may also charge upfront legal or valuation fees, which may not be so flexible.
Exit fees on variable rate loans have been banned for some years. However, if you're refinancing a fixed-rate loan it's important to consider timing. "The end of a fixed term may be an ideal time to consider your options," says Charters. "If you're still in the fixed term, though, you may be faced with penalties to refinance."
These penalties can come in the form of "break" costs, which are designed to compensate your lender for loss of revenue if you bail out of a fixed rate prematurely. How much you pay will vary according to a range of factors, including the size of your loan, how variable rates have moved and how far into the fixed term you are.
In the worst-case scenario, you could face break costs running into thousands of dollars, particularly if market rates have dropped since you locked into a fixed rate. The only way to know exactly what you could be up for is to speak to your lender. If the break costs are high, it can be more cost effective to sit out the remainder of your fixed-rate term and refinance when the loan reverts to a variable rate.
Another danger can arise if your new loan will be for more than 80% of your home's current market value. In this case you can expect to pay lenders mortgage insurance (LMI) even if you paid it when you first took out your loan.
LMI is not cheap - as a guide, if you're refinancing a $380,000 loan on a home worth $440,000 (meaning you're borrowing 86% of the property's value), LMI could cost $5340, potentially wiping out the savings of shifting to a new loan.
Malkoun says it's uncommon for refinancers to be hit with LMI given property price growth over recent years.
Nevertheless, he cautions that one situation where LMI can be payable is where a first homeowner refinances a family pledge loan for which relatives (often mum and dad) have acted as guarantor.
If that sounds like you, check the LMI calculator on the website of mortgage insurer Genworth (genworth.com.au) for the likely premium. Bear in mind that LMI protects the lender, not the homeowner, so it's a cost worth avoiding or at least keeping to a minimum.
Possibly the biggest trap of refinancing is not going "like for like". Malkoun says a homeowner may be five years into a 25-year home loan but refinancing could see the new loan have a term of 25 or even 30 years. Dragging out the time it will take to pay off your home may lower the monthly repayments but the downside can be a significantly higher long-term interest cost. The way around this problem is to explain to your new lender or broker that you want a term that matches the term remaining on your current home loan, says Malkoun.
With a firm figure of what it's going to cost to refinance your mortgage, it's possible to calculate how long it will take to recoup these expenses. If, for instance, your new loan provides savings of $50 a month, and it's going to cost $600 to refinance, you could be looking at 12 months before you break even. "Ideally, it should be a short time frame to recover the costs of refinancing," says Malkoun. "Three to six months is a benchmark worth aiming for." Much longer than this and you run the risk that an even better deal will come along.
Three steps to make refinancing easier
Greater Bank's Simon Charters says homeowners can take three important steps to prepare for refinancing.
1. Spruce up your collateral
To maximise the value of your home and help ensure the loan to value ratio is above 80%, make sure your property is in good order. Make minor repairs, add a fresh coat of paint and give it a good tidy up, inside and out.
2. Show you can handle the repayments
Minimising your credit card and other personal debt will show good financial discipline. Maintaining a good repayment history on all your existing debts is important - failing to meet repayments won't be viewed favourably by the new lender when assessing your application.
3. Get a headstart on the application
Pull together documentation such as ID, payslips and/or tax returns, as well as recent statements for all the debts being refinanced.
This report was sponsored by Greater Bank but was independently researched and written.