5 Wise Strategies To Refinance Your Mortgage

Wise strategies to refinance your mortgage

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There are plenty of reasons why people choose to refinance their loan to benefit from a lower interest rate, or switch to a different loan type, or access equity to finance renovations or the deposit on an investment property.

While you can refinance to a better overall loan, what that means to each person is quite individual. So it’s important that you should always try to aim for a lower overall cost and a loan that has the right features for you.

Whatever your motivation, you shouldn’t rush your decisions when refinancing.

You need to make sure that you understand the cost of refinancing, and work out how long it will be until you get back out in front. You should also weigh up a couple of options, including staying with your current lender.

If you’re not sure whether you’re getting the best deal on your mortgage, right now is the time to health check your loan and compare it to other products.

Refinance Strategy #1: Debt Consolidation

Borrowers commonly refinance so they can consolidate all of their debts, such as their mortgage, car loans, credit cards and personal loans into one credit facility.

While this is a common strategy, there is definitely a right way and a wrong way to go about it.

If you decide to consolidate your debts, you should ask your broker to synchronise but maintain the consolidated debt as a ‘split’ separate to your original home loan.

A ‘split’ has its own statements and repayments, but it has the same interest rate as your main mortgage. This helps you to avoid one of the biggest problems for most people – out of sight, out of mind.

This is what happens when you consolidate your personal debts into your home loan, and then – because the smaller amounts have disappeared into a much larger mortgage – you “inadvertently slip back into bad habits”. You continue to pay the minimum due on the mortgage and then run up a new debt on your credit card, and within 12 months you’re right back where you started, but with a much bulkier home loan by your side.

Consolidating debt as a separate split is a reminder of how vulnerable you are to letting credit get the better of you. It also helps you see how quickly you are or are not fixing the problem. Even though refinancing will probably reduce your minimum monthly required payment, you should aim to keep your payments at current levels to make sure you are actually taking advantage of the lower interest rate.

Refinance Strategy #2: Releasing Equity

In recent years borrowers have tapped into the equity in their home for a whole host of reasons – to use as a deposit on an investment property, for example, or to renovate their home, or upgrade the family car.

Today, however, accessing the equity in your property is not as easy as it once was. There are many variables to be taken into account, and it very much depends on the lender, the borrower, the type of loan, and urgency of the loan as to how successful you’ll be at the moment.

The primary issue revolves around the property’s value. To have equity to access in the first place, your property needs to be worth more than your loan.

If you have a loan of $200,000 secured against a home worth $370,000–400,000 for example, you have a strong equity position of $170,000–200,000, and you should therefore have no trouble securing additional funds via refinancing.

However, if you have a loan of $330,000, lenders may be less inclined to increase your mortgage. Assuming your property is worth $370,000– 400,000, a conservative bank valuation might bring the value down to $360,000, leaving you with an equity position of just $30,000 – less than 10%.

Once a low valuation has been received it is virtually impossible to get the bank to change the valuation.

Bottom line

Only consider this option if you’re confident that the value of your property will stack up. Call several valuers and ask them to give you a general idea of what they think about the area, and what you could expect them to value your property at. Once you’ve ascertained a worst-case valuation figure, decide whether refinancing to access equity is the right move for you.

Refinance Strategy #3: Switching To a Lower Rate

If you’re chasing a lower interest rate, the golden rule to remember is that interest rates fluctuate constantly – so one of the cheapest rates available today may become one of the more expensive rates in six months’ time.

Banks and non-bank lenders increase and decrease their product rates at their own discretion, so a small rate differential shouldn’t be enough to prompt you to switch.

If you think you’re being hard done by, find out a little bit about the lenders that you think are offering a better deal, then pick up the phone and have a chat to them.

If you discuss your intention to move to another lender, they might offer a rate discount, or suggest a more suitable low-rate mortgage from their product range.

Not satisfied with their response? Start shopping for a better deal because there will always be a competitor offering a lower interest rate.

Bottom line

Approach your broker first and make sure you’re getting the best possible rate with them – and if you’re not, see what options are available. A good broker has better buying and negotiating power than an individual borrower. They offer the lender repeat business – and this will be reflected in your effective rate.

Refinance Strategy #4: Moving To Another Lender

The Australian mortgage market is flooded with financiers, from large banks to credit unions, building societies and non-bank lenders.

The one thing they have in common is that they all want your business – because, despite the credit crunch and lenders’ subsequent conservative policies, lending money is how they generate profits.
Lenders are always motivated to retain your business. If you decide to move to a new lender, make sure you read the fine print of your current contract first.

You also need to consider that your new lender will value your property when processing your application, and in the current market, there is the risk that they will cautiously value your property for less than your current lender’s valuation.

Bottom line

Don’t refinance to a new lender simply to access a cheaper interest rate: instead, look at the overall cost of moving including all fees and charges before you switch.

Refinance Strategy #5: From Low-Doc To Full-Doc

Lenders currently consider low documentation (low-doc) borrowers to be riskier propositions than full documentation (full-doc) borrowers. High-risk loans are often attached to higher interest rates, so low-doc borrowers should be carefully evaluating their mortgage and their financial situation at the moment.

If you can prove stability in your job and your finances with a solid paper trail, you may be able to switch to a full-doc loan with your own lender.

A borrower can go from a low-doc loan to a full-doc loan by providing financials for one to two years, depending on the lender. There may be a lower interest rate or other benefits gained from going from low-doc to full-doc, but this very much depends on the lender.

The paperwork involved can be substantial, but if a rate saving of 1% or more is on offer, it’s worthwhile chasing it up.

The borrower would be required to provide current financial statements, including individual tax returns for the last two years and any company, partnership and trust returns where income is derived via these means. Profit and loss statements may also be requested in some instances.

However, for your trouble you will almost certainly attract a lower interest rate.

Bottom line

If you move from a low-doc loan to a full-doc product, you may stand to gain huge interest rate savings – but even if you don’t access a rate saving, you may benefit from other advantages such as lower ongoing fees and more flexibility.

Current Risks Of Refinancing

The turbulence in the Australian and global economy has prompted more than a few headaches for borrowers and lenders alike. For those who are considering refinancing, the current risks you need to watch out for include:

1. Valuations

Valuations represent one of the biggest challenges facing the property market because at the moment people still believe that their properties are worth more than they actually are.

Get at least three quotes from real estate agents to try and determine real value, because lenders and valuers are increasingly erring on the side of caution.

2. Cost-benefit analysis

When people are fearful or unsure how to proceed, they are more vulnerable to being talked into doing something they don’t entirely understand.

Don’t even think about refinancing until you understand the benefits you will receive, over the costs involved in doing the refinance.

It’s important that you:

  • Ask your current lender what costs would be charged if you were to break the loan
  • Ask the lender what the costs are to take the new loan
  • Calculate the difference in rates, and work out an annualised saving

Then it’s just a simple matter of adding the savings and deducting the costs to see the benefits. Benefits may not actually be savings, but things such as access to new loan features or further cash equity – but at least by doing this, you can see the real cost for the benefits gained.

3. Negative equity

If you currently have a high borrowing ratio – that is, your loans equate to more than 80% of the value of your property assets – then there is a chance that you are currently in or near a negative equity situation.

Negative equity in itself is not a huge problem – but it becomes an issue when you are forced to sell or refinance, thereby formalising that loss.

If you refinance through the bank that you currently have your loan through, the valuation may come up low and reveal that you owe more than the property is worth or that the LVR was too high. Then, under your loan agreement, you may be technically in default of your loan – and your lender can ask you to repay the loan, or at least repay a significant amount, to bring the loan back to a lower LVR.

If you are highly geared or you are concerned that your property’s valuation might have slipped, your best move would be to steer clear of refinancing for now.

Ready To Refinance?

If you’ve added up the pro’s and con’s of refinancing your mortgage and have decided that now is a good time for you to reassess and get a better rate then request a call back from one of our Mortgage Experts and we’ll show you how much you can save with our Bank Beater Home Loan.

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About Martin Anstee

Martin is the Managing Director and co-founder of Illawarra Home Loans.