Refinancing: How To Stay Afloat When Circumstances Change

refinancing when plans change

In this article we explore some of the issues to bear in mind when some of the more common life-changing scenarios come your way and how you can refinance your mortgage to ease the financial burden.

Refinance Scenario 1: Rising Interest Rates

Interest rates may have remained stable throughout 2011, but it’s always prudent to plan for rate rises in the future. An interest rate increase of 1%, for example, means an extra $199 on monthly payments on a $300,000 mortgage.

Say you’re looking to upgrade to a larger property and take out a 25-year $500,000 variable principal and interest mortgage, for example, and the current interest rate being offered by your lender is 7%, which would mean a monthly payment of $3,534. Another 1% rise in interest rates would increase your payments to $3,859: that’s an extra $325 a month, or $3,900 a year

What if you can only just afford your current level of payments, but you’re not sure how you’d be able to afford the higher rate: should you go ahead?

The key here is planning ahead. Like most big decisions, planning is paramount when it comes to taking a suitably-sized mortgage. Not only should you be looking at your budget to see how much surplus you would have with which to make repayments, but you also need to consider what would happen if interest rates increase.

Step one is to do your research

We have a large selection of online mortgage calculators available for you to get an estimation of how much you could borrow based on your income and expenses, or you can also request a call back and an experienced mortgage consultant can give you a personalised estimation over the phone and advise on repayment size.

Our mortgage consultants will be more than happy to give you an estimation of repayment sizes for interest rates as much as 2–4% higher than what you’ll be paying now to ensure you can manage repayments if rates rise in the future.

Then, it’s down to tough choices: if you honestly don’t think you’ll be able to meet the payments at the higher interest rates, the chances are you’re punching above your weight and need to borrow less.

What expenses you could reduce if required?

Perhaps you could consider renting out a spare room to help cover the additional costs?

Your contingency planning should also cover things like having children, or being unable to work for a period of time. It is also a good idea to talk to a qualified financial advisor about income protection and health insurance before getting a mortgage.

Pay More To Reduce Financial Strain

If you can make the sums work – whether on your existing home loan or refinancing your mortgage to a smaller one – one way to prepare for any potential interest rate rises would be to make repayments at 2-3% pa higher than the initial interest rate.

Not only will this help to reduce your loan more quickly, but it would also reduce any financial strain should interest rates go up, as you’ve already been making repayments at a higher rate from day one.

Plan ahead

Plan ahead for the worst case scenario of not being able to service your mortgage. Talk to a financial planner or accountant to find out what avenues are available to get out of, or write off, your debt, and plan to have ‘trigger’ points or limits which will motivate you into action.

For example, plan to speak to us at a certain stage, to see if we can arrange a modified repayment plan, and see what – if any – other options are available.

Loan Variations

Common options include repayment holidays – although these are typically short-term solutions – and conducting a ‘loan variation’ with to a cheaper interest rate or increasing the term of the loan. Both of these options would see your monthly repayment fall.

Loan variations can also be used to make part or all of a loan interest-only. This would lower your repayments and provide extra money to help make ends meet – however, while it may take off some of the financial pressure, it may also increase the time it takes to pay off your mortgage.

Know When To Sell

Finally, know at what stage you will put your house on the market once you’re unable to make the repayments, rather than begging and borrowing from friends and family in order to fight a losing battle.

Get real estate appraisals on your property every few years, so that you have a rough estimate of what your property is worth should it come time to sell.

Refinance Scenario 2: Dropping An Income To Start A Family

Starting a family comes with a whole host of challenges and rewards, and if doing so requires one of you to drop your income to take care of the family’s newest member then you may need to do some serious budgeting to keep your home loan afloat.

Some lenders do offer a maternity option, but whether they’ll offer you any respite will depend on how much you still owe on the property.

If you’ve managed to make inroads into your home loan – through overpaying or offsetting for example – then there may be scope to reduce your repayments and make the debt more manageable.

Say, for example, you’ve made some over-payments on a 30-year loan during the first 10-year period. It might then be that it will only take you 15 years to pay off the debt, at current repayment levels, rather than 20. You can then go to the bank, explain that you’d like to restructure your repayments to make full use of the 20 years left on the loan term and see your regular repayment amount shrink accordingly.

You’ll end up paying more in interest over the full term than you would have if you paid off the loan early, but reducing your regular repayments in this manner might enable you to keep hold of a property that would otherwise have been impossible to hold on to.

Of course, it might be the case that you’re able to keep up with your current repayments on the one income or you’ve planned ahead and put a buffer fund in place to prepare for the single income scenario.

In this situation, although technically the small print of your home loan will tell you to inform the bank if your situation changes, if you’re making your repayments then the bank’s unlikely to come asking questions about your circumstances.

With that in mind, plan ahead, do your sums to make sure repayments will be affordable after you drop down to one income, and do any borrowing whilst you’re still a dual-income family.

One point to bear in mind, however, is that new responsible lending criteria requires brokers and lenders to make reasonable inquiries about applicants to make sure that they’ll be able to meet repayments without going through substantial hardship.

Refinance Scenario 3: Divorce

Sadly, divorce is a changing circumstance that affects many Australians. The latest ABS figures, for example, show that in 2009, 120,118 marriages were registered, while the number of divorces that were granted was more than a third of that figure at 49,448.

So how do you divide up your property with a separation?

In terms of agreeing on how to divide up a couple’s wealth, Macpherson+Kelley family law specialist Fran Fox explains that the legal process follows four basic steps.

1. Establishing the value of assets

First up, the value of all assets to be carved up will need to be established, so with regard to property this will normally involve bringing in independent valuers.

2. Contribution to the assets

Next up, some consideration will need to be given to how those assets were acquired and how each partner contributed to the acquisition and maintenance of those assets.

“If it’s a relatively long marriage for example, and one of them has worked more than the other – who has done the child raising – then legally their contributions are going to be roughly equal,” explains Fox. “One contribution is financial and one’s not, but there’s not going to be a differentiation.”

“Where that would become different is if, for example, one partner argued that they’ve only got all these assets because they’re such a brilliant investor,” she adds. “So that’s clearly an argument that could happen.”

The length of the relationship will also be taken into account. So if one partner had already managed to buy themselves a $1m property before meeting their spouse, for example, then they’re more likely to be able to keep the lion’s share of this asset if they separate after five years than if they separate after 30.

3. Considering each partners future financial needs

Next up, consideration needs to be given to what each partner’s going to need financially in the future. This, says Fox, is difficult to assess as it’s unusual that both parties will be on equal incomes when they separate.

To make things more equitable, the divorce settlement can boost the lower earning partner’s income either through giving them capital (eg, a property) or an income stream (typically a spousal payment from the higher-earner). So it may be that a capital asset such as a property is given over to the lower-earning partner to meet their ongoing financial demands.

4. Work it out in the Family Court

And if negotiations over these three steps fail, then step four is to go to the family court to argue out an equitable solution. “And that’s the million-dollar question,” says Fox, “because this whole area of law is very discretionary.”

In terms of how lenders view your situation, they’re unlikely to ask any questions unless the relationship breakdown results in mortgage arrears. However, it’s all too common that a breakdown in communication means separating partners put themselves in exactly this situation – and risk the bank taking action and forcing a sale.

Inform us of your changing situation as soon as possible. How we can help you out, however, will depend on your home loan, and on your personal circumstances.

What about applying for a loan post-divorce?

According to ABS 2009 figures, the median age for males at divorce was 44.4 years, compared to 41.5 years for females, and these medians have been increasing for both sexes over the past 20 years.

These statistics make for compelling reading in conjunction with the new responsible lending rule regarding putting clients under substantial hardship, which some lenders have interpreted as a direction to get strict on applicants who are approaching retirement.

If you’re looking to fund the purchase of your own home, and you’re within a decade or two of retirement, then the lenders may look at restricting the length of the loan term.

The responsible lending rules are constantly under review, and this is evidenced by a recent update from the credit regulator, the Australian Security & Investments Commission (ASIC):
“We are concerned by reports of older borrowers whose employment will reduce, or cease, before the end of the loan term, being refused loans because some lenders are adopting an unnecessarily restrictive approach to meeting the responsible lending requirements. Undertaking the range of enquiries required by the legislation will often reveal other ways that they will be able to repay the loan,” says ASIC Commissioner Peter Boxall.

“The new responsible lending requirements in the National Credit Act are an important protection for consumers, but they should not be an inflexible barrier to credit for any segment of the population, and should not prevent consumers obtaining credit that they can reasonably afford.”

The ASIC Amendments Included:

• Clarifying that a conclusion of substantial hardship (where a borrower appears to have no obvious continued income stream for the full life of the credit contract) can often be rebutted with reasonable enquiries about the borrower’s financial situation, requirements, and objectives
• Providing further guidance on issues a lender should consider when assessing the relevance of income from a person – other than the borrower – in assessing the borrower’s capacity to repay.

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