Should You Refinance Your Home Loan? A Complete Guide
Before deciding to refinance your home loan, it’s worth considering benefits, drawbacks, financial circumstances and credit score and expert mortgage advice.
It's one of the most common questions we hear and we're glad to know that you've turned to experts for advice, because refinancing a home loan is:
- A big decision
- Unique to your situation
So, it's important that you take the time to consider everything properly and make the best decision for yourself.
Benefits of Refinancing
The obvious question to start with when you’re considering refinancing your home loan is: what are the benefits? Essentially, will it help you and, if so, how? Your needs and financial circumstances change over time and your home loan should reflect that, and yet many people don’t realise the benefits that they could be missing out on by keeping the same home loan for too long.
It's time for a loan health check on your current loan package.
Lowering Your Interest Rate
If you see an opportunity to capitalise on lower interest rates available to you by replacing your current loan with another, it’s worth taking the time to research these options.
This could become possible when market rates drop overall, meaning you can reduce your monthly repayments and overall interest rates if you refinance your home loan. You can also lower your interest rates if you have improved your credit criteria.
Managing your credit by paying down debt or even making extra repayments on your existing mortgage to give yourself a higher credit score could encourage lenders to offer you a better rate by refinancing. Switching to a different loan type could also improve your interest rate compared to your current home loan.
Modifying Loan Terms
As your personal and financial situation changes, refinancing your home loan could allow you to find a mortgage that better fits your needs, goals and situation. This could include modifications like shortening or lengthening the loan term (i.e. from a 30-year term to 15 years or 15 to 30-year loan) to reduce interest rates by increasing monthly payments or vice versa depending on your situation.
If you plan on staying in the home long-term, switching from an adjustable-rate mortgage (ARM), A.K.A variable rate, to a fixed-rate mortgage could protect you from rate rises with your current lender.
Accessing Home Equity
A cash-out refinance option gives you the chance to access home equity, which can be very useful if you’re considering home renovations but you’re hesitant to invest heavily out of pocket. This can be a higher-risk option but, if you have a high credit score and stable income, this can be a particularly good way to carry out home improvements and increase your property value.
Switching Lenders for Better Terms
As we’ve already explored, other lenders may offer different loan terms, loan features and better interest rates among other factors that could make it financially wise to refinance your home loan elsewhere. This becomes a more feasible option when you have improved your own credit score, which can be done by paying off credit cards and avoiding new credit applications.
Consolidating Debt
Consolidating debt through your mortgage can save you a lot of money over time thanks to lower interest rates on mortgages (compared to unsecured debts like credit cards and personal loans). If you have outstanding debt, the option to refinance your home loan with a cash-out refinance or debt consolidation refinance could be a long-term money saver.
Drawbacks of Refinancing
High Closing Costs
The fact of the matter is that refinancing your home loan can be expensive. High closing costs include appraisal fees, application fees, loan origination fees, property valuation fees, a mortgage registration fee and other administration costs.
With these refinancing costs usually coming to somewhere between 2-5% of the total loan amount, this could cost you thousands. It’s important to weigh these costs against the money you could save and other benefits of refinancing your home loan in the long term.
Lenders Mortgage Insurance
Lenders mortgage insurance (LMI) is a potential additional cost that can come up when you refinance your home loan. This is an insurance policy that your current lender might have taken out. It’s more likely to be an issue if you owe 80% or more on your home and, as the lenders mortgage insurance can cost you thousands of dollars, this can have a significant impact on how profitable or worthwhile it would actually be to refinance your home loan.
Comparison rates might look better in your financial position, but an LMI could nullify the benefits of a better mortgage rate.
Impact on Credit Score
Whilst the initial impact of a “hard enquiry” during your loan application might be relatively brief and insignificant in the broader picture of your credit score, accessing equity through an equity loan and increasing your loan balance can have a negative impact on your credit rating; highlighting you as higher risk and raising alarm bells for prospective future lenders.
Risk of Losing Equity
This particular risk of refinancing your home loan can get complicated, but the core overarching point is that if your home value decreases after you take a cast-out refinance (usually for home improvements) then you could end up owing more than the house is worth. This leads to negative equity and can cause serious financial strain further down the line.
Key Considerations Before Refinancing
Evaluating Your Credit Score
Changes in your credit score could be a key influential factor in deciding to refinance your home loan. If you now have a higher credit score than you did when taking out your current mortgage, you will likely qualify for lower interest rates in your loan repayments which, if you do refinance, could save you money over time.
Understanding Loan-to-Value Ratio
Your loan-to-value (LTV) ratio will directly impact the loan terms and loan conditions you’ll be offered, including loan interest rates. This is essentially the percentage of your home’s value that is financed through the loan. A lower loan-to-value qualifies you for better interest rates and makes refinancing a more viable option for you. If your loan-to-value is above 80%, you are unlikely to qualify to refinance, particularly for cash-out refinancing. This is usually required to be even lower for an investment property.
Assessing Financial Goals
As we discussed at the beginning, when talking about the benefits of refinancing, finding a mortgage that fits your financial circumstances better is a key reason for refinancing your home loan. Whether that means reducing monthly payments in the short term or reducing long-term interest rates, this gives you the best option for your personal situation moving forward.
Timing
Of course, the loan market rates will often dictate how beneficial refinancing your home loan will actually be. Combining this with your own credit score, financial goals and loan to value will be decisive.
The best times to refinance are:
When interest rates decrease across the market
When you encounter a significant change in your personal circumstances
When fixed-rate loan terms are expiring
It would be less advisable to refinance:
During a fixed-rate home loan
During low-equity situations
If you plan to (or anticipate that you might) move soon
Make an Informed Decision on Refinancing
Ultimately, expert professional advice is invaluable when you are considering refinancing your home loan. Attempting to navigate the mortgage, loan and finance market without a mortgage broker and loan specialist's expertise is high-risk, which is why leaning on specialist advisors is incredibly worthwhile.
You can get in touch with us now to take advantage of our financial knowledge, guiding you towards better decisions by avoiding pitfalls and capitalising on opportunities.