What is refinancing?
In simple terms, refinancing is trading an existing home loan in for a new one on new conditions – usually with a different lender.
Refinancing involves going through the full process of applying for and establishing a new loan on your home. Once it’s approved, the new loan amount is used to pay out the existing mortgage on the property – and may also be used to pay off other personal liabilities that you might be trying to knock over in the process (like credit card debts, for example). Refinancing is often used as a way to consolidate debt.
Why do people refinance houses?
Home loan refinancing is very common. Below are a few of the reasons that property owners choose to refinance:
- To repay existing personal liabilities such as outstanding personal loans or credit card debts – which are likely to carry with them much higher interest
- To improve your property with an addition, extension, general renovations or a swimming pool or spa.
- Refinancing may provide the opportunity to secure a loan at a lower variable interest rate - or to switch a portion or the entire loan amount to a fixed rate loan if interest rates are on the rise.
- To raise funds to purchase a new car or to fund a big overseas holiday
What are the advantages of refinancing?
Whether or not there are advantages to refinancing – and just how big those advantages will be – will really depend on your own circumstances. For example, if you’re carrying around a significant credit card or personal loan debt, then refinancing offers you the chance to pay it off at what’s likely to be a considerably lower rate of interest.
Likewise, having a single consolidated debt will also help you manage repayments – it’s much easier to deal with a single debt than it is to juggle many at once.
The other big advantage in refinancing – depending on the situation - is that it can potentially act as a way for you to free up funds for strategic improvements to your home. Clever renovations can significantly add to the value of your house if you know what you’re doing, improving your equity.
Likewise, depending on your existing agreements, refinancing can also help to reduce the rate of interest you’re paying on your loan.
What are the disadvantages of refinancing?
There are potential downsides to refinancing, of course – many of which boil down to the kinds of fees and charges you’re liable to be up for.
It used to be that the banks charged hefty ‘exit fees’ for people trying to change mortgage lenders early on, but these were abolished in 2011, making refinancing a much more attractive prospect.
What still remains, however, are:
- the application fees you’ll need to pay for the new loan
- ‘break’ fees if you’re wanting to switch out of a fixed interest loan
- discharge fees from your current lender
- various other bank and government fees
The sum of the fees you’re likely to be up for is likely to be in the thousands, and can significantly reduce the advantage to switching lenders. These fees are often rolled into your new mortgage – in a sense, coming out of your home equity (i.e the part of the house you’ve already paid off).
If you’re only refinancing for a better deal it’s a good idea to assess how long it’ll be until you’re likely to sell your home, and whether or not the fees associated with switching lenders are actually worth the hit to your equity.
As you can imagine, the most sensible option is quite often to simply talk to your current lender and see what they can do. If you’re not switching lenders when you refinance, you shouldn’t need to pay Lenders Mortgage Insurance (LMI) again, nor many of the other fees that are involved.
Things to be aware of
If your financial circumstances have changed (for example, if your husband or wife stops working to raise a child or go back to uni), there’s a chance that your ability to service a loan may also change. You may find that as a result, the loan conditions that are available to you aren’t as attractive as the ones you already have.
Likewise, if you’re thinking of switching lenders (something that’s likely to attract bigger fees in general), it’s also worth remembering that you may need to pay Lenders Mortgage Insurance (LMI) again on the new loan. How much the LMI will cost will depend on the loan-to-value ratio (LVR), which is calculated based on the value of your home. If the value of your home’s changed significantly since you first applied for your existing loan, you may also find that the cost of the mortgage insurance is different the second time around too.
For more information and advice on whether refinancing is right for your needs and circumstances, consult your current lender, a broker or a financial advisor. Remember though, anyone you talk to about refinancing is likely to benefit from selling you something, and it’s always wise to do your own careful research and shop around.