21 May 2007

Refinancing your home – everything you need to consider

When the Reserve Bank of Australia decided to further reduce the cash rate to 0.1% - the lowest it’s ever been, it boosted housing affordability and gave mortgage holders and home buyers an incentive to refinance their loans. But since different people have different financial situations, refinancing may not be the best option for everyone.

Contrary to popular belief, refinancing your home is not a sure-fire way to improving your financial situation. It’s also not just about lowering your interest rate. And it is definitely not always a good idea. So when should you consider refinancing, and what is the best way to do it?

1. Your current rate is no longer competitive and better deals are available

A lower interest rate does not always mean a better loan offer. While a lower rate could make a big difference in the overall amount you pay towards your loan, it should not be the sole reason you refinance.

Many borrowers often overlook the fact that most low interest rate loans are also low on features and flexibility. More often than not, a variable loan with low advertised rates will vary the rate within six months and charge a very different, and much higher rate while not allowing you to make extra repayments or have an offset account.

With the current low-rate environment, many loan sharks will offer seemingly amazing deals. But there’s always a catch. Before signing on the dotted line, make sure you do a lot of research and compare multiple offers from multiple lenders. Or better yet, discuss your options with a trained professional; we know exactly what to look for.

2. Your financial or personal situation has changed

If your credit score has improved since you got your loan, it might be a good idea to refinance. Your credit score has a direct effect on your loan applications and the offers you get from lenders. With a low credit score, the only way to secure a home loan may be to accept higher interest rates. So, if your score has improved, you may qualify for a lower interest mortgage.

Keep in mind that if your credit score has dropped, it might work against your refinance attempts. Additionally, rejected refinance applications could have a further negative effect on your credit score. Be sure to talk to an experienced adviser to help you assess your situation.

With that in mind, sometimes a refinance could be used to consolidate debt. If you have enough equity on your property, it could help you improve your financial situation if you consolidate all your debt into a single large repayment. This would help you simplify your finances and save, sometimes drastically, on interest rates.

However, if you view consolidation as a get-out-of-jail-free card for the thousands of dollars of debt you’ve racked up on your credit card, you might want to think again.

Consolidating a collection of small debts into a home loan with a 30-year term may keep your monthly commitments low, but it comes at the cost of paying much more interest in the long term.

The right way to do it is to attempt to finish paying off the loan as quickly as possible. Consider adjusting the loan repayment to equate the total of what you were paying for all your loans collectively. Larger repayments and shorter loan terms could save you thousands of dollars.

3.Your home value has changed or you have accumulated equity

Equity is the difference between your remaining loan balance and the current value of your property. This is why lenders require a home valuation is conducted when you want to refinance. If your home’s value has increased, you can use this equity as a deposit for your second purchase or to consolidate debts. Make sure you have at least 20% equity or you may have to pay Lenders Mortgage Insurance (LMI).

The more equity you build up, the greater your borrowing power. You could use this equity to leverage a lower interest rate, consolidate debts, as a deposit on another property, or towards your holidays or for renovations.

4. Do the gains outweigh the costs?

Sadly, refinancing isn’t free. It comes with a variety of fees and charges such as application fees, valuation fees, discharge fees, LMI, and if your current home loan is fixed, a rather expensive break fee. These can sometimes amount to a few thousand dollars.

Make sure you factor these costs in when choosing to refinance. Compare your current repayments with the total savings you would make from the new loan, and remember to include the fees.

Ask yourself why you are refinancing and what you stand to gain overall:

-Are you only refinancing for a better interest rate or are there more reasons?

-Do you want a more flexible loan? Will the new loan offer more features or more regular repayments?

-Are you aiming to consolidate your other debts into your home loan? Will this be beneficial and sustainable in the long run?

-Are you looking for a shorter or longer loan term?

-Do you need access to equity?

There are many details to consider before you make this decision, so before you do anything, make sure you get expert guidance. Give us a call, our home loan experts are more than happy to help.

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