Refinancing is the process of replacing one mortgage with another, generally because the new loan is better in some way than the old one.
How does home loan refinancing work?
- Imagine you have $500,000 outstanding on your loan with Lender A.
- You decide to refinance to Lender B.
- Lender B pays off your loan with Lender A.
- So now you owe $0 to Lender A and $500,000 to Lender B.
To refinance, you need to make a new home loan application. That means you need to provide the new lender with all the standard documentation – including ID, bank statements and payslips – so the lender can assess your capacity to repay the loan. It also means the lender will conduct a valuation of your property, to assess its potential resale value.
What is the cost of refinancing a home loan?
When refinancing your home loan, costs vary between a few hundred to a few thousand dollars depending on the lender. According to Canstar, the average fee is $831.
You will generally need to pay a home loan application fee and a valuation fee, and potentially some other fees as well. Furthermore, you will likely have to pay your original lender a discharge fee to cover the admin cost of closing out your loan. Also, if your original loan has a fixed rate, you might need to pay a break fee as well.
Why consider refinancing your home loan?
One common reason people refinance is to reduce their monthly repayments. Depending on the size of your loan, the number of years left on your loan and your current interest rate, switching to a loan whose rate was, say, 0.50 percentage points lower could save you tens of thousands of dollars over the life of your loan – which would far exceed the switching costs.
Another reason people refinance is to change their interest rate type – for example, from fixed to variable or principal-and-interest to interest-only.
People also need to refinance if they want to ‘cash out’ some of the equity in their home, potentially to fund the deposit on an investment property or pay for renovations. They may also refinance to help consolidate other debt into their home loan.
Given that refinancing incurs costs, you need to weigh these up against the potential benefits.
When should you consider refinancing?
Refinancing suits some borrowers some of the time. The above reasons are the times when many people may consider refinancing, however determining whether it is the right choice for you depends on a number of factors.
For example, it would generally not be a good idea to refinance if you’d almost paid off your loan because the time remaining on your repayments may not be long enough to recoup the refinancing costs. You’d also likely experience little benefit from switching or you had less than 20% equity in your home (as you’d probably have to pay lenders mortgage insurance).
As a general rule of thumb, refinancing might be worth considering if you had at least three years left on your loan, your new loan would be considerably better than your current one and you had at least 20% equity in your home.
Reach out to your Loan Market broker for more advice around refinancing. They can answer any questions you might have, crunch the numbers for you and let you know if refinancing would be suitable for your situation.
