Is refinancing my home loan worth it?

Refinancing your home loan is currently the talk of many property and finance media commentators, especially in light of the Australian property market and rising interest rates. Throughout the 2010s and especially during COVID, interest rates were at historically low levels which meant that home owners mainly refinanced to achieve lower rates and take advantage of refinance cashbacks. In the post-COVID era, as inflation is soars, despite telling the public there would be no rate increases until 2024, the RBA has responded with an unprecedented rate increase causing great financial stress for many Australians.

On top of this, there is a significantly large volume of fixed rate home loans expiring in the next 6 to 12 months which in turn, is incentivising home owners to explore refinancing their home loans again in order to avoid any “loyalty tax” from their existing lenders.

What is refinancing?

Refinancing a loan is a financial strategy that involves obtaining a new mortgage to replace your existing one. Often, homeowners resort to this strategy when they find a lender that offers lower interest rates than their current loan. Generally, the primary objective is to save money over the life of the loan by securing a lower interest rate, reducing the monthly repayment, or shortening the loan term.

Refinancing can also serve other financial purposes, including (but not limited to) consolidating debts, cashing out equity for personal use or investment purposes, changing loan purposes (e.g. changing from an investment loan to an owner occupied loan), changing loan product (e.g. changing from a variable loan to a fixed loan), or changing loan repayment type (e.g. changing from principal and interest repayment to interest only repayment).

Each of these purposes are viable and refinancing a home loan needs to be assessed at a wholistic level as there will be pros and cons to each option that your mortgage broker (such as Reservoir Finance) will present to you.

Why do people consider refinancing?

Homeowners refinance their mortgages for various reasons. The most common reason is to take advantage of lower interest rates, which can result in significant savings over the life of the loan.

Another common motive is to shorten the loan term. For instance, if a homeowner initially took out a 30-year mortgage but can now afford larger monthly payments, they might refinance to a 15-year mortgage. By doing so, they would pay off their home quicker and pay less in interest.

Changing the type of mortgage is another reason to refinance. For instance, switching from an variable rate mortgage to a fixed rate mortgage can provide stability in monthly repayments. This is particularly useful for those who prefer predictability and plan to stay in their homes for a long period.

Consolidating debts may be another good reason to refinance. Liabilities like personal loans and credit card balance may incur very high interest rates, much higher than property loan rates. By consolidating those debts may give you an overall much better financial position and pay less interest payments.

Lastly, some homeowners might choose to refinance to tap into their home’s equity. Home equity is the value of your home minus how much you owe a lender. If your house’s price has increased, you have more equity. In those situations, you can choose to refinance and “cash out” some of this equity to use for other purposes. This strategy, known as ‘cash-out’ refinancing, allows you to borrow more than you owe on your current mortgage and receive the difference in cash. This cash can then be used for home improvements, paying off other high rate debts, investing or any other significant expenses.

Many of these purposes may have tax implications so it is highly recommended you consult with your accountant or tax advisor as well as your mortgage broker when considering a refinance of your home loan or investment property loan.

Advantages of refinancing your home loan

There are several potential benefits to refinancing your home loan, though they largely depend on your financial circumstances and the terms of the new loan.

Firstly, if interest rates have decreased significantly since you have secured your original mortgage, refinancing could allow you to reduce your interest costs substantially. Lower interest costs mean you pay less money to the bank and more towards the principal of your loan, allowing you to build home equity faster.

Inversely, as interest rates are rising, if you are on a variable home loan, refinancing can still be beneficial as some lenders offer lower interest rates to new customers rather than existing. This means having your home loan reviewed periodically (Reservoir Finance offers this service for free) by a mortgage broker that offers this service can be extremely beneficial in savings over the long run.

Secondly, by refinancing to a loan with a shorter term, you can fast-track your path to becoming debt-free. While this may result in higher monthly payments, the overall interest paid throughout the life of the loan would be significantly lower.

Thirdly, by refinancing to a loan with a longer term (e.g. a fresh new 30 year term), you can lower your repayment even if the interest rate stays the same. While it gives the benefits of lowering repayments and allocating funds for other things, this will surely result in a higher total interest payment over the life of the loan.

Refinancing could also bring about stability in your repayments if you switch from a variable rate loan to a fixed rate loan. The predictability of a fixed interest rate can be advantageous for budget planning, as you’ll know exactly what your repayments will be for the life of the loan.

Additionally, a cash-out refinance could provide you with a substantial cash amount. If your home has appreciated significantly, this can be a relatively cheap way to fund major expenses or investments.

Lastly, even though there aren’t as many lenders offering refinance cash rebates, refinancing your home loan to another lender can result in you receiving some cashbacks ranging from $2000 to $4000.

Disadvantages of Refinancing

While refinancing can present several advantages, it also has potential downsides. Understanding these will help you make a well informed decision.

One of the most significant drawbacks is the costs associated with refinancing. It is important to understand that refinancing is not free. Similar as to when you secured your original home loan, you will be subject to various potential fees and charges, including application fees, valuation fees, settlement fees, discharge fees, government charges, and possibly break costs if you’re exiting a fixed-rate loan early.

A common misconception about refinancing is that it automatically results in paying less interest. While it’s true that a lower interest rate reduces the amount of interest on each repayment, extending the loan term means you’ll be paying interest over a more extended period, which could result in more total interest paid over the life of the loan. This issue can be overcome by either keeping the same remaining loan term (principal and time) or keeping the same repayment figures each month).

In an environment of decreasing interest rates, refinancing from a fixed rate loan to an variable rate loan might initially seem attractive. In essence you are “betting” against the bank as you are predicting whether interest rates will increase or decrease significantly over the life of your loan term.

In an environment of increasing interest rates, refinancing from a fixed home loan rate to a variable rate home loan generally is not recommended unless you are fulfilling another purpose or the fixed rate you were in was high comparative to the market.

Finally, if you opt for cash-out refinancing, remember that it means you are reducing your home equity, which could be risky if property prices fall. Additionally, the larger loan amount means you will need to repay more over the life of the loan and maybe increase your monthly repayments too.

Factors to Consider When Refinancing

Determining whether or not to refinance your home loan requires a detailed assessment of your personal and financial situation. Below are some considerations:

Current Interest Rates

This is one of the most significant factors to consider. If current interest rates are considerably lower than when you took out your original loan, refinancing could potentially save you a lot of money over time.

Refinancing Costs

Refinancing involves several fees and charges. It’s crucial to consider these costs and determine whether the potential savings from a lower interest rate or shorter loan term will outweigh these expenses.

Credit Score

Your credit score significantly impacts the lender and loan product you choose, and therefore it impacts interest rates available to you. If your credit score has improved since you took out your original loan, you may qualify for a lower interest rate (e.g. refinancing from a small lender with a near prime loan to a major bank loan, which may typically reduce the interest rate by over 3%).

Home Equity

The amount of equity you have in your home can impact your ability to refinance and the terms of your new loan. If you have significant equity, you may be able to secure a better rate or even access some of this equity through cash-out refinancing.

Financial Goals

Your long-term financial goals should guide your decision to refinance. Whether you aim to reduce your monthly repayments, pay off your loan faster, switch to a more predictable repayment structure, or access cash for a significant expense will influence whether refinancing is right for you.

Affordability

While your mortgage broker and your lender will assess the affordability for you to get a new refinancing loan, being a responsible borrower, you may need to assess your budget and affordability according your lifestyle and financial goals, to make sure the refinancing (especially if it comes with a cash out) is the right thing for you.

How to Decide if Refinancing is Worth It

Deciding whether refinancing is worthwhile largely comes down to the numbers, lender product offerings and your personal situation. It would be best if you calculated your break-even point, the point at which the savings from the lower rate (or shorter term) equal the cost of refinancing. If you plan to stay in your home beyond the break-even point, refinancing might make financial sense.
However, this decision should also take into account your personal circumstances and financial goals. If reducing your monthly payments, securing a fixed-rate loan, or accessing cash is a priority for you, refinancing might be worth it, even if the numbers are close.

Steps to Refinancing Your Home Loan in Australia

The process of refinancing in Australia involves several steps. You can read our more detailed article here. At a high level the steps to refinance your home loan are:

Research: Start by comparing loans from different lenders. Consider the interest rates, terms, features, and fees of each option. Mortgage brokers such as Reservoir Finance can help save time (and money) as they know the offers and deals from each of the different lenders and will be able to help recommend the right home loan(s) for your situation.

Apply: Once you’ve chosen a lender and loan, you’ll need to complete an application and provide necessary documentation.

Approval: The lender will assess your application, which will likely include a credit check and property valuation.

Settlement: If approved, your new lender will pay off your old loan, and the new loan will be established.

Repayments: You’ll start making repayments on your new loan according to the agreed schedule.

Conclusion

Refinancing a home loan is a significant financial decision that requires careful thought and analysis. While it can provide numerous benefits, such as lower interest rates, shorter loan terms, access to extra cash, and cash rebate, it also has potential drawbacks, including refinancing costs, longer loan terms, and reduced home equity.

By understanding the dynamics of refinancing and considering your personal circumstances and financial goals, you can make an informed decision that aligns with your financial wellbeing.

In Australia, specific considerations such as the Reserve Bank’s decisions, government policies, and the state of the local property market further add to the decision-making mix. By keeping abreast of these factors, you can better time your decision to refinance and maximise its potential benefits.

If you need help or someone to speak with to refinance your home loan and understand your options, Reservoir Finance is more than happy to speak with you! We are an independent mortgage broker and offer free consultations (with no obligation to continue) and strategy sessions. We also do not charge fees to 99% of our clients (unlike other mortgage brokers) as we are confident in our services. Contact us today using the form below or call us! We’d love to partner with you to help you move forward with your goals.

    This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.