"A mortgage broker would be valuable in assisting a borrower through all these various factors to consider." - Elisha Mapusua
Doing so can help you to either generate savings or leverage your wealth growth. But like many things in the money world, refinancing can sting you if you’re not careful, so there are a few things you should consider before refinancing your home loan.
What to consider before refinancing a home loan:
1. Why refinance?
Take the time to properly consider exactly why you want to refinance your home loan.
Ask yourself:
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Are you after a cheaper rate?
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Do you want more flexibility in the loan (e.g. with an offset account or redraw facility)?
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Are you consolidating debt?
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Do you need to access the equity to pay for something major such as a renovation?
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Do you want to increase or shorten your loan term?
Having a clear understanding of what you hope to achieve by refinancing can help you make a better decision.
2. Costs to refinance a mortgage
The numerous costs of refinancing a home loan can sometimes set you back thousands, leaving you wondering whether it was worth it.
To avoid any nasty surprises, look at the terms and conditions of both your existing home loan and the loan you’re looking to refinance with to discover what the ‘change’ costs will be, including discharge fees, valuation fees, break costs, etc.
If you’re refinancing to get a lower interest rate, you should first calculate how much less you’ll pay in interest at that rate (you can do this using our home loan repayments calculator) and compare this saving to the total cost of refinancing. That should give you an idea of whether the refinance is worth it.
You may find that through the interest savings, you’ll make back the refinancing costs within a year. If it’s going to take a several years to recoup the cost of switching, you may need to consider other options.
3. Property value & your equity
Whether you’re refinancing to secure a lower interest rate or to free up some cash from your home loan, you need to consider the current value of your property and how much equity you have in it.
You can use loan-to-value ratio (LVR) as a measure of equity. This is expressed as a percentage. So, if your home is worth $700,000 and you owe $350,000 on your home loan, your loan-to-value ratio is 50%.
As property prices rise (as they tend to do over the long term), the equity in your home can also rise. You may have started out with a standard loan-to-value ratio of 80%, purchasing your property for $500,000 with a $100,000 (20%) deposit and a $400,000 home loan
A rise in your property value, along with reducing the amount you owe on your loan, will naturally increase the equity you have - in this case from 20% to 50%. At the same time, your loan-to-value ratio has reduced from 80% to 50%.
When refinancing to get a cheaper interest rate, a lower LVR will generally stand you in good stead. But if you’re looking to refinance with an LVR higher than 80%, you may struggle to qualify for the lowest interest rates on the market.
If you’re seeking to refinance with another lender, you may also face having to pay for Lenders Mortgage Insurance (LMI) – even if you already paid for it when you took out your original loan.
When refinancing to access some of your equity (for example, to pay for a renovation or to invest it in another property), you’ll generally be able to borrow up to 80% of the property’s value minus the outstanding debt.
So, if your property is worth $700,000, you would be able to borrow 80% of that, or $560,000, less the amount you owe on your loan, $350,000. That’s $210,000 in equity freed up from your home loan which could go some way for paying for renovations or another property.
Borrowing any more than that would push your loan-to-value ratio beyond 80% LVR which many lenders may not be comfortable with. But lenders' policies vary considerably. If you’re looking to refinance, it pays to shop around for a lender that best meets your needs and circumstances.
4. Credit rating
Have you checked your credit rating recently? If it’s not so great, you might find it working against your efforts to refinance.
Also, refinancing represents an application for credit, which also appears on your credit report and can influence your credit score.
Lenders can be wary of those who refinance too often, so having numerous mortgage refinances on your credit report can affect your interest rate bargaining power or indeed your eligibility to refinance.
5. Current home loan interest rates
It pays to be across what interest rates are doing in the home loan market and what a variety of experts are predicting. If interest rates are expected to rise over the next few years, you might want to consider refinancing to a fixed rate home loan.
A mortgage broker can provide some general advice regarding expected movements in the market, but it pays to do your own research before you decide to refinance.
Full Article: Savings.com.au