Refinancing – How it works

Refinancing – How it works

What is refinancing?

Refinancing is the process of replacing an existing loan with a new one. With home loans, it means your existing home loan is paid off and replaced with a new one. This is different from a second mortgage, where you draw on the equity you have built up in your home. People may choose to refinance for a variety of reasons. For some it maybe to consolidate debt, saving on costs through a lower interest rate or fewer fees or to access other home loan features such as offset accounts or the ability to fix their interest rate.

How refinancing can help me save?

Refinancing can have a huge impact on your mortgage, even a decrease of 0.10% over a 25 year period would result in $1,000’s of dollars in savings, based on your average home loan. This can be a great way of saving without adjusting your lifestyle at all. Also consider that refinancing your mortgage may be more than just being able to reduce your repayments. It could be a chance to access the equity (the value of your property minus the amount you still owe on your loan) you’ve built up in your property, or to restructure your mortgage to better suit your lifestyle.

Good reasons to consider refinancing

You want a lower interest rate

The loans market is highly competitive and interest rates can vary significantly between lenders, so one of the most common reasons for refinancing is to get a lower rate. This could help you pay off your home loan sooner and save you thousands of dollars over time or to reduce your monthly payments if you prefer.

Even if interest rates haven’t fallen since you first took out your loan, you can sometimes access a better rate by refinancing if your current financial situation has improved. This is where a broker can be an asset by  helping to find a more favourable interest rate and advising you of lending choices that may suit your lifestyle and situation. Sometimes rather than moving banks, you could renegotiate a better deal with your existing lender.

It is important to keep in mind however, that not all mortgage products are the same. A mortgage with a lower interest rate may not have all the benefits of your existing loan, so be sure to carefully consider all rates, fees and features. Before taking any action, talk to your broker as they can help you go over refinancing in detail.

You want to change your loan type

When refinancing you may want to switch from a variable loan to a fixed loan to lock in a low interest rate with either your existing lender or a new one. Depending on the type of mortgage you have, this may require refinancing into a different product. You might also have to refinance if you want to change to a split loan, which has part variable and part fixed rates.

You’d like to access the equity in your home for other uses

As you pay down your mortgage and property values increase, the equity you have in your property builds up and becomes a valuable asset. By refinancing, you can access that equity to generate funds to use in a wide variety of situations including to renovate or extend your home, for a deposit on an investment property, or even to invest in shares.

Your circumstances have changed

Things change. Perhaps you’ve had a significant change in your income. Refinancing can help to manage your new situation. By taking out a new mortgage (or increasing your limit on the existing one), you may be able to consolidate other debts such as personal loans and credit cards into one facility lowering your monthly repayments and saving you interest. If your finances have improved, on the other hand, you may want a different kind of loan product with alternative features such as a mortgage offset or extra repayment facility to allow you to pay off your mortgage sooner.

The process of refinancing

Once you’ve determined your needs and done your research, including speaking to a broker, the process of refinancing will be straightforward.

The application

Your broker will evaluate your circumstances and help you submit your application. You’ll need to provide identification documentation, proof of income (such as pay slips) and an assets and liabilities list. If you’re staying with your existing lender you may not need to provide as much information.

Getting a valuation

Lenders will often require a valuation on your home to determine how much you can borrow. This bank valuation generally requires an inspection of the property by a licensed valuer. Remember to prepare for the valuation ensuring your property is presented in its best light to gain an accurate valuation price. Tidy the garden, reduce clutter in the house and finish those small maintenance jobs you’ve been putting off.

Receiving approval

Once your lender is completely satisfied, full loan approval is granted. In many cases you’ll receive an approval letter with a copy of the loan contract to review, sign and return to the lender. Your funds will usually be cleared once all signed documentation is reviewed. Your lender will then arrange settlement of your existing loan and establishment of your new one.

While refinancing can save you money, it may not be the right move for everyone. Take care and get advice on whether it’s the best route for you. Before taking any action please talk to your broker as they can help you select a suitable loan product for your needs and circumstances.

Features to consider about refinancing

Most mortgages offer a number of features and benefits. If you’re considering refinancing, it’s a good idea to think about which features are important to you before starting a search for a lower interest rate.

Variable rate or fixed rate

A fixed rate gives you more certainty over the longer term. A variable rate fluctuates with the market so you’ll save when it’s down but there’s always a risk it will rise. (In January 1990, for example, the Australian home loan interest rate reached an all-time high of 17.5 per cent).

Offset account

Cash in hand can be offset against your loan balance until you need to spend it, potentially saving you interest.

A line of credit

If you have a lot of equity in your home, a lender might be prepared to offer you a relatively inexpensive line of credit secured against the property.

Repayment flexibility

Repaying a loan fortnightly rather than monthly can make it easier to fit in your budgeting plans.

Early pay out

You may want the option of paying a loan out early with a minimal penalty.

Weighing up the costs

There can be costs associated with refinancing and it’s important to factor these in to your decision-making. For example, if you took out your loan before 30 June 2011, the lender might be able to charge you an exit fee for terminating the loan ahead of schedule. If yours is a fixed-rate mortgage, you might have to pay a break fee.

For a new mortgage, you may have to pay an establishment fee and the ongoing administration fees could be higher than you’re currently paying. And if your loan has redraw facilities, there may be a charge each time you take money out of your account.

Do the maths

You can use an online mortgage calculator to work out what repayments will be for different loan amounts at different interest rates.

You can also compare fees and charges to ensure they won’t offset any savings in interest over the life of a loan. The Australian Security & Investment Commission’s MoneySmart website has a useful mortgage switching calculator that can help you assess overall costs.