What is refinancing?
Refinancing is when a borrower changes their home loan product with one that usually has a lower rate than their existing lender or a new lender.
Borrowers typically refinance their mortgages to get a lower rate or update their loan characteristics and terms to keep up with the ever-changing credit landscape.
There are two types of refinancing:
- External – When you switch your loan to a mortgage product provided by another lender.
- Internal – When you switch your loan to a mortgage product provided by the existing lender.
What is a home loan refinance?
A refinance home loan refers to the home loan product borrowers turn to. Lenders sometimes offer a different set of home loans with their respective rates and characteristics for refinancing applications.
When your home loan is left unchecked for a period of time, it can be insignificant compared to the new loan products offered to new applicants. It is therefore ideal for you to regularly review your loans and see if refinancing is necessary to ensure that your mortgage is still as competitive as the current market.
Why should I refinance?
While refinancing seems as easy as changing your loan or lender, knowing that this is a viable financial strategy that could help you in many ways is essential. Here are some cases where it would be better to refinance:
Access lower mortgage rates
Perhaps the most common reason borrowers refinance is to access lower mortgage rates. Borrowers who stick to their current mortgage for too long are usually subject to the so-called “loyalty tax”. Lenders generally offer more competitive home loans to first-time buyers or new customers, especially when the official cash rate is lowered. This leaves existing borrowers with a slightly higher interest rate than new ones in the market.
Change the loan term
Another reason behind many refinancing requests is to change the term of the loan. Depending on your situation, you may feel the need to shorten or lengthen your amortization period.
By doing this, you can either pay more monthly but finish paying off the mortgage quickly, or have lower regular repayments but over a longer loan term.
When you shorten your loan term, you need to be prepared for higher repayments. On the plus side, you will be able to save a lot on interest charges in the long run.
On the other hand, spreading your loan over a few more years will help ease the financial burden. However, this will make you pay more interest over time.
Change mortgage conditions
If you currently have a variable rate home loan and want to be able to secure your interest rate, you will need to refinance to a fixed rate mortgage.
You can lock in your interest rate for up to five years. This way, your mortgage rate will not be affected, even with a potential increase in the official spot rate.
Variable rate refinancing can be tricky – if you’re currently in the middle of a fixed term and have decided to switch to a variable rate, you could end up paying the breakage fee.
Equity of access
As time goes on and you pay off your mortgage, you also increase your home equity. This means that the proportion of the total value of your home that you actually own is increasing.
Many borrowers take advantage of their own funds to refinance themselves. If the housing market is on the rise, chances are their properties have appreciated as well.
Refinancing will allow you to take some of your accumulated capital and use it to finance any major purchase, such as investment property, a new car, or a renovation.
Consolidate debts
Refinancing is also a good idea if you want to streamline all of your other debts in addition to your mortgage into one loan.
This makes sense when it comes to personal loans, which often have higher interest rates. The regrouping of these credits in mortgage will allow you to free up space in your budget and to manage your finances more effectively.
Be aware, however, that when you consolidate your other loans into your home loan, you will end up paying a slightly higher interest rate.
How much does it cost to refinance your home loan?
The cost of refinancing usually involves an up-front cost similar to the cost of first applying for a mortgage. Most of the time, these fees vary depending on whether you are refinancing externally or internally.
Application Fee
These fees come under several names, including the setup fee and upfront fees. This one-time payment, which is typically charged when you refinance with a new lender, covers the administrative costs of setting up a new mortgage.
Assessment fees
If you are applying to a new lender, you may need to have your property appraised at its current market value.
Discharge Fee
These fees cover the administration fees required by your current lender to terminate your loan agreement.
Breakdown costs
You will have to pay these fees to your lender if you are in a fixed term period when you refinance.
Settlement Fee
This will cover the costs of the settlement process if you are refinancing a new loan with a new lender.
How to refinance a home loan
To start your refinancing plans, you must first review your current home loan, its interest rate, and its features. You will need to compare your current mortgage with the new ones currently available on the market.
Before considering switching to a new lender, first ask your current lender what options they might offer you. Consider how much it would take to refinance based on your goal.
You can talk to a mortgage broker to broaden the scope of your options. A mortgage broker can help you determine which lenders and loan products are right for your current financial needs.
Once you’ve decided on the best option, prepare all the necessary documents, submit your application and documentary requirements, and wait for approval.
If you are changing lenders, let your current lender know that you are refinancing. Your new and existing lender will take care of the process once you get approved – you just need to prepare your portfolios for the fees.
When not to refinance
While refinancing is a viable financial strategy to relieve some of the stress you have with your mortgage, there are many scenarios where it’s best to stick with your current mortgage.
If you have a low credit score
This requires you to examine your credit score before attempting to apply for refinancing. Refinancing with a low credit score will only get you a higher rate than your current rate.
If you are still on a fixed-term contract
It is advisable to complete your fixed term first before refinancing with a new loan or new lender to avoid significant breakage costs.
If your equity is less than 20%
When you refinance with less than 20% equity, you’ll end up paying mortgage insurance from lenders, which protects your lender in the event that your loan defaults.
If you plan to sell soon
It may be a good idea to keep your current mortgage if you plan to put your home up for sale in the near future, as the costs may outweigh the benefits of refinancing.