Refinance your existing home loan

Executive Summary

The information below discusses reasons why people refinance their home loan and some of the benefits and advantages of doing so.

Introduction

In a time not too long ago, home loans were forever. They were hard to get and when you had one you kept it until you sold up. Well, deregulation of the Australian banking system in 1986 sorted that out. Once banks had the right to borrow money overseas the supply of money became plentiful and with the entry of non banks into the market in the early 1990s, downward pressure on interest rates created immense competition in the home loan market.

This continues today, even though the ability to borrow money overseas is not as robust as it used to be. Cheaper rates and a proliferation of innovative new products set the scene for the refinance of home loans, on average every 4 to 5 years. Some of the reasons people refinance include:

New Products. Once upon a time there was the standard home loan that required repayments of principal and interest every month for 25 years. The Commonwealth Bank funded these until other banks were able to enter the market. These loans had a variable rate, for many years at a rate less than 6% and that was it. No functionality at all. The maximum loan to value ratio was about 65% so the deposit was 35% plus costs.
Since then we have seen the introduction of products with fixed rates, redraw, 100% offset accounts, interest only repayments, split rate loans, split product loans, lines of credit with cheques and cards attached and so on. New loan products emerge regularly and this might be one reason you would consider refinancing of your home loan, particularly if the loan you have does not have the features you require.

You Change. Over time, your personal and financial situation may change. Your family grows. You change employment. As your needs and priorities change you may want to refinance your loan to improve your current circumstances. This is quite common with business owners who need to support borrowings for their business.

Get a Lower Rate. This is the most common reason for people to refinance their loan. In times of rising interest rates this is not unreasonable, especially if you can lock into an advantageous fixed rate. In July ‘09 the Prime Minister stated that variable interest rates would rise by up to 1% in the next 12 months. The average variable interest rate of the major banks is currently 5.77%. If the government’s expectation is realised, then variable rates will be around 6.7% within a year. Two and three year fixed rates can still be obtained at rates below this, so they should be considered right now. Fixed rates give certainty for a period.

More Flexibility. With modern flexibility in home loans it is not surprising that borrowers want to change products. We discussed some of the later innovations above so if you don’t have those because your home loan is very basic then you could research what is available and see if it is something you could use.

Home Renovation. A common reason to refinance your loan. Renovations and additions are a suitable alternative to moving home for many families. In most cases you should be able to add on to your existing loan at cheaper cost.
Home Equity. Commonly called “freeing up the equity in your home.” What does this mean? Usually it means increasing your home loan to buy a boat or a new car or take a holiday etc.

Loan Consolidation. Got too many consumer loans? Got a car loan and a few too many credit cards? Struggling to keep the payments up? This is a well known problem that catches up with many of us at some stage. This is where a loan consolidation can be really handy. Provided there is enough equity left on your home loan ie the loan to valuation ratio is low enough that you can increase the loan, hopefully without paying Lender’s Mortgage Insurance, you could apply for loan consolidation ie put all those loans together with your home loan and have just one payment per month. This payment will be less than what you currently pay because the payments via a loan consolidation will be spread out over up to 30 years, whereas the existing consumer loans and cards must be paid back in a short period of time. Many people do this because they move to a job with less income etc but for people who just spend, taking this option also comes with a reality check, that their ways must change and some discipline must be invoked. The lender may insist that all of the cards must go, so it is up to the borrower to not weaken and take out new facilities at a later stage. Loan consolidation can be very helpful but usually it should only be done once.

Default. This is when the home loan repayments can’t be made. The absolute best thing you can do if you think you will not be able to pay on time is to go to your lender and make an arrangement. Failure to do that, which seems to be in most cases, will give a bad signal to the lender, who then has to contact the borrower. It becomes difficult to refinance to a loan with a reasonable interest rate once the loan falls behind. Get in early. Arrange a buffer if you can, to see you through the difficult times.

Poor Mortgage Broker Service. Whenever someone tells me that they want to refinance their loan we usually refer them back to the Mortgage Broker who wrote the loan in the first place. About 1 in 10 accepts the offer. Most people don’t want to know their previous Mortgage Broker. They either haven’t heard from them in 4 years, or they have gone out of business or they were disappointed with their service at the time of arranging their loan. So if they hadn’t contacted me they would be off to see a different Mortgage Broker. This usually puts them in the position of having to refinance with another lender and therefore another set of costs. A good Mortgage Broker will stay in contact, will provide a regular health check on your loan, say every two years, and recommend things to improve your position. This will save you money and may include refinance of your loan to get a better deal. Be aware of the Mortgage Broker who wants to “churn” you to a new lender every two years because he can make a new fee out of it. There has to be a real benefit in it for you.

Purchase an Investment Property. Such a purchase invariably means providing the family home as additional security, particularly if you borrow the total cost including set up fees and stamp duty.

As you can see, there are many reasons why people refinance their loans. Regardless of the reason, it is important to go to a better deal – one with a better rate or with better loan features that you will definitely use. Don’t pay for features you won’t use.