Refinancing: Benefits or Risky Business?
During the Global Financial Crisis interest rates were at historically low levels, and a lot of Australians were able to take on home loans at very favourable interest rates. Since October 2009 the Australian Reserve Bank official cash rate has increased six times, the lending institutions have quickly followed suit, and interest rates have returned to levels somewhere near the average of the past decade. As the official cash rate is still relatively low, there is potential for home loan rates to keep moving upwards for some time. Some people who took out new home loans a couple of years ago, during the low-interest period, are thinking about refinancing.
Benefits of a Home Loan Refinance
Every month in the days leading to the Reserve Bank meeting to set the official cash rate, there is a barrage of media reports highlighting the effects of interest rate increases. To reduce the financial pressure resulting from increases in interest rates, many homeowners are now considering refinancing their home loans. In refinancing, many are hoping to:
- Get protection from interest rate rises. Many people with variable interest home loans have already had to cut back on day-to-day living expenses to pay monthly repayments that rise each time interest rates creep up, and they worry that they won’t be able to afford any further increases. Fixed rate mortgages appeal to people who have budget constraints; these people, who have had a degree of security in knowing exactly what their monthly repayments are for the time being, are afraid that when the fixed rate term expires their monthly loan repayments will be unmanageable. News of further interest rate rises is unsettling to both these groups of homeowners who see refinancing as a chance to switch to a home loan with monthly repayments that they are more comfortable with.
- Minimise the cost of switching loans. While a refinance deal can provide escape from spiralling home loan repayments, people are now more aware of the need to take account of all the costs of switching home loans. When choosing a new home loan that offers both manageable repayments and long-term savings on interest over the length of the loan, they are alert to short-term costs and charges to be paid when they refinance. Some of these costs are paid to their existing lender when the loan is paid out, and can run into thousands of dollars. The new lender also charges fees for setting up the new loan. These payments have to be made upfront at the time of switching loans (when the borrower’s finances may already be stretched to the limit) and can erode any long-term savings achieved by refinancing.
Risks of a Home Loan Refinance Deal
One of the biggest risks of refinancing is a hasty choice of a new loan. If you’re under financial pressure it can be very tempting to choose a loan that seems to offer a solution to your crisis. You need to step back and ask yourself two questions:
- Have I researched the market thoroughly? The best way to find the best refinance deal for you is to do your homework. This means being clear about how much you are able to pay each month and how much interest you are prepared to pay over the length of the loan, and carefully comparing the fees, interest rates, repayments and conditions of your current loan against the fees, rates, repayments and conditions of a wide range of home loans on the market. It’s an essential but tedious task.
- Is refinancing my only option? Having done your research you’ll be armed with a lot of background knowledge about how your current loan competes with loan products currently available. If you negotiate with your current lender you may find that there is scope to change the terms of your existing loan in a way that suits you, so that you get the benefits of a new loan without the cost of refinancing.
Do I really need to refinance?
You already have a relationship with your current lender. If you’re looking to make long-term savings on a home loan it’s worth considering whether:
- Your lender will change your existing loan. The terms and conditions of your current loan aren’t necessarily set in concrete and your lender may have the scope to make compromises in order to keep your business. If you could negotiate some changes in the terms of your existing loan to make it more competitive, you’d have the benefits of effectively a new loan without the cost and bother of refinancing – and your lender would have retained you as a customer.
- You can change the way you pay your existing loan. Instead of making the minimum monthly repayments on your home loan there are other payment options that help you to pay it off more quickly. Among the possibilities are: payment on a fortnightly or four-weekly rather than monthly basis, making larger monthly payments when you can afford to, and paying windfalls such as tax refunds and annual bonuses into your loan account.
Questions to Consider
- What is the cost of switching to this loan? If, like most people, your aim in refinancing is to save money, be conscious of the costs involved in taking out a new loan. In addition to the immediate upfront payments to the new lender to set up the loan, you may have to pay substantial fees to compensate your existing lender when you pay out your current loan. There may also be sizeable government stamp duties to pay on the new loan. The costs you have to pay for discharging your current loan and taking out a new one need to be balanced against the long term savings it offers.
- How long will it last? Sometimes home loans are advertised with enticing low introductory interest rates. When calculating the cost of a home loan it’s important to take account of the interest rates that will be charged when the introductory low-interest period expires. And when you’re considering a fixed interest rate home loan, it’s essential to be aware of interest rate movement trends to help you decide if now is the best time to take up a loan: a fixed interest loan benefits you best if the rates are fixed near the start of a rising trend rather than when they’ve reached their peak.
Now that you know something about the benefits and risks of the refinance process, you’re in a position to compare the different home loan offers available.
Related posts:
- Benefits of Refinancing a Home Loan
- Benefits of refinancing with Commonwealth Bank
- Best Refinancing Loan
- Costs of Refinancing
- Refinancing Risk
- How Does Refinancing Work?
- How Mortgage Brokers Can Help with Refinancing
- Refinancing Closing Costs
- Weighing Up The Costs Of Refinancing
- When Refinancing Doesn’t Make Sense
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