How to get the best deal when you refinance your mortgage

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It was the year of the "big switch".

In the 10 months to November 2021, $150 billion worth of home loans were refinanced - about $10 billion more than for the whole of 2020. If you've had the same loan for a few years, now could be the time to move to a new lender - and it can be easier than you think.

"We've seen refinancing snowball through COVID," says Scott Adams, a Sydney-based senior mortgage broker with Aussie Home Loans.

how to get the best deal when you refinance your mortgage

"It's been driven by a big uptick in property values, a dramatic fall in fixed rates and the availability of refinancing rebates - also known as cashback deals - which have been worth $2000 to $4000."

He says most homeowners are refinancing to make the most of their equity.

"Refinancing purely for a dollar-for-dollar swap to get a better rate is not unusual," he says.

"But more commonly, people have an additional goal in refinancing, such as opportunities to consolidate debt or release home equity to buy a new car or investment property."

New customers favoured

It's no secret that lenders save their best deals for new customers.

"Banks rely on customers who don't switch - the 'complacent' borrower. These customers are paying a higher rate than new customers," says Jack Talbot, director of broking firm Leverage Capital.

Reserve Bank data shows the average variable rate on existing loans is 3%. For new loans the average is 2.63%. The 0.37% difference can see refinancers save close to $100 each month on a $500,000 loan, and shave almost $29,000 off the total interest cost over 25 years.

But you could do a lot better. Comparison site Mozo says the lowest rate across its database is 1.77% through Reduce Home Loans. Other super-low variable rates are available to refinancers through Athena (1.99%) and Nano Home Loans (1.99%). Or take a look at Money's 2022 Best of the Best winners - Macquarie Bank (2.19% at the time) and Mortgage House (1.98%).

The savings can be especially dramatic if you've stayed loyal to your lender for a long time. In 2020, the Australian Competition and Consumer Commission found borrowers with home loans aged from three to five years paid on average about 0.58% more than the average new loan rate. On loans aged 10-years-plus, the rate gap widened to 1.04%.

As Talbot puts it, "Long-term customers are subsidising new customers. Yet you are getting no extra benefit for paying a higher rate."

How do I refinance?

Refinancing can sound complex, but it doesn't have to be.

The starting point can be asking your current lender for a better deal. It's a simple step that costs nothing. But there's a catch.

"They're likely to give you some level of discount, but it won't usually be the rate a new customer will pay," says Jack Talbot.

If that's the case, the next step is to speak with a lender or mortgage broker: you'll get access to a much broader selection of home loans than the handful of products an individual lender can offer.

The service of a mortgage broker shouldn't cost you anything, as they're paid by the lender, and they'll take care of the inevitable paperwork.

why now could be the time to refinance your mortgage

Traps to avoid

Once you've found a deal you like, the process of applying for a new loan works in much the same way as when you took out your old mortgage, though there are four key pitfalls to watch for.

1. Will you pass the buffer rate test?

"Refinances are assessed in much the same way as home buyers," says Aussie's Scott Adams.

"The lender will look at your credit score, income, expenses and other debts. Lenders will also apply a buffer rate, which the bank regulator APRA recently raised to 3%, up from 2.5%. This is affecting everyone across the board."

In practical terms, the buffer rate means a lender will check how well you can manage loan repayments assuming you're paying an extra 3%. So, on a loan costing 2%, you'll be assessed as if the rate was 5%.

The upshot is that it's worth speaking to a broker or lender to understand how much you can borrow, especially if you're hoping to increase your loan.

2. Will your home's valuation pass muster?

As part of refinancing, a lender will want to value your home. Talbot says rising prices mean a valuation shouldn't be a problem for most homeowners, especially those looking for a dollar-for-dollar refinance.

The crunch can come if you're hoping to dip into a solid chunk of home equity. NSW-based Nola White* had planned a refinance as part of a debt consolidation strategy.

"Between my husband and myself, our combined annual income is about $200,000," she says. "So we thought we'd have no trouble getting approved for a bigger loan."

Crunch time came when the Whites' home came in with a far lower valuation than they anticipated.

"That meant we didn't have enough equity to support our application, which put an end to the whole deal," she says.

This can be a surprisingly common problem.

"Most of us tend to over-value our homes," says Adams. However, there can be solutions.

"If a property valuation comes in below the owner's expectations, they may need to apply with other lenders, which can mean paying a higher rate.

"Otherwise, borrowers can choose to wait for a variety of home sales to settle in their area. This can bump up the valuation because banks rely on the value of settled sales, which can change market values."

Waiting it out is exactly what the White family is doing. If you're concerned about how your place will stack up at valuation time, Talbot says a broker can order a valuation through a lender at no cost to the homeowner and it won't impact their credit record.

3. Know what your "lending equity" looks like

One of the biggest traps of refinancing can be the prospect of paying lenders mortgage insurance (LMI).

It arises because of misconceptions around how much home equity is available to borrow against.

To avoid LMI, Adams says homeowners need to maintain 20% equity in the property.

To see how this works, let's say your home is worth $1 million and you have a $500,000 mortgage.

That would bring your home equity to $500,000. But this is not the same as "lending equity", which is what banks are interested in.

Using the above figures, a bank will calculate lending equity as:
• 80% of $1 million (the home's current value) = $800,000
• $800,000 minus $500,000 (the outstanding home loan) = lending equity of $300,000

"Borrowing above the 80% level will mean paying LMI and often higher interest rates," says Adams.

"This can be a wake-up call for potential borrowers."

The real sting is that it doesn't matter if you've already paid LMI when you purchased the property.

Exceed the 80% equity benchmark and you could be slugged for LMI a second time by the new lender.

Adams says there can be valid reasons to wear the expense of LMI. "The homeowner may have a guarantor who wants to be released from the guarantee, or they could be on a significantly higher rate."

4. Pick your new loan term with care

As part of the refinancing, be sure to let the lender know your preferred term. You shouldn't automatically be rolled over into a repayment term of 25 or 30 years. If there's only 10 years remaining on the old mortgage, you can request a 10-year term for the new loan.

That said, Talbot says the choice of loan term can be linked to future goals. "Opting for a longer term will  mean paying more interest over time, but it can lower repayments and free up extra cash for personal goals like starting a business."

What it will cost

Refinancing is likely to come with fees and charges, making it important to weigh up the costs of switching against the benefits.

Expect to pay:
• A mortgage discharge fee levied by your old lender.
• State-based land registration fees to remove the old mortgage and replace it with the new home loan.
• Upfront fees charged by the new lender, including loan application and valuation fees.

These costs will vary depending on your old/new lender as well as where you live. In general, Scott Adams says refinancing can come with a total tab of about $1000. Cashback deals can leave refinancers with money in the hand.

Some of the biggest cashbacks for refinancers are offered by RAMS ($4000), HSBC ($3288), Bank of Melbourne, ING and BankSA (all $3000). Nonetheless, the savings from a competitive rate can be worth a lot more over time than a cash sweetener. Your mortgage broker can crunch the numbers to show whether a cashback deal offers long-term value.

As you approach the last leg of refinancing, your old lender will need to be notified of the loan discharge. This is something that needs to be done by the borrower, and while it's a matter of filling in some forms, it can result in an unexpected phone call.

"Your old bank's retention team may get in touch and offer a lower rate to discourage you from leaving," says Talbot.

However, he adds that by this stage most customers choose to leave anyway, often having made up their mind to move on when an earlier request for a rate discount was met by a lukewarm response.

*Not her real name

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A former Chartered Accountant, Nicola Field has been a regular contributor to Money for 20 years, and writes on personal finance issues for some of Australia's largest financial institutions. She is the author of Investing in Your Child's Future and Baby or Bust, and has collaborated with Paul Clitheroe on a variety of projects including radio scripts, newspaper columns, and several books.

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