As a homeowner, you may wonder, “Should I refinance my home loan now?” With interest rates on the rise and home values experiencing a downturn, it’s natural to feel uncertain about making such a crucial financial decision.
Refinancing can offer several benefits, including reduced interest payments, shorter loan terms, and access to equity for other purposes. However, you should also weigh these potential advantages against the costs and risks involved, such as fees and the possibility of higher rates in the future.
Below are the key factors that could influence your decision to refinance your home loan so you can make a choice that best suits your unique financial situation.
What is refinancing a home loan?
When you refinance your home loan, it means you’re obtaining a new mortgage to replace your existing one. When you refinance, your current mortgage is paid off, and a new one takes its place. The new mortgage may have different terms, such as a different interest rate, repayment period or loan structure.
Types of refinancing options available to homeowners
- Rate-and-term refinancing. This is the most common form of refinancing, where the interest rate and/or the term of your existing mortgage is changed. The primary goal is often to reduce your monthly payments, shorten your loan term, or switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.
- Cash-out refinancing. With this option, you can tap into your home’s equity by borrowing more than you currently owe on your mortgage. The difference between the new and old mortgage balance is paid out in cash, which you can use for various purposes, such as home improvements, debt consolidation, or investing.
- Cash-in refinancing. This is the opposite of cash-out refinancing, where you pay down a portion of your existing mortgage balance with a lump sum of cash. This can be done to lower your loan-to-value ratio (LTV), secure a lower interest rate or eliminate private mortgage insurance (PMI).
- Fixing your interest rate refinancing. This involves switching from a variable to a fixed interest rate for a predetermined period, providing homeowners with stable and predictable monthly mortgage payments.
Are refinance rates usually lower?
Refinance rates are not always lower than the original mortgage rates, but many homeowners choose to refinance when market conditions make it possible to secure a more favourable interest rate.
Whether your interest rates will go down when you refinance depends on several factors, some of which are within your control, while external market conditions dictate others.
Factors that influence refinance rates
Current market conditions
Interest rates are influenced by economic factors such as inflation, unemployment and the overall health of the economy. If market interest rates have dropped since you took out your original mortgage, you can secure a lower rate through refinancing.
A high credit score indicates to lenders that you are a lower-risk borrower, which can help you qualify for a more competitive interest rate. If your credit score has improved since you obtained your original mortgage, you may be eligible for a lower rate when refinancing.
Loan-to-value ratio (LTV)
This is the ratio of your mortgage balance to your home’s current value. Lenders see a lower LTV as less risky, which can translate to better interest rates. Therefore, if your home’s value has increased or your mortgage balance has decreased significantly, you may qualify for a lower refinancing rate.
Debt-to-income ratio (DTI)
Your DTI is the percentage of your monthly gross income that goes towards paying off debts. A lower DTI suggests you have a manageable debt load and can comfortably afford your monthly mortgage payments. If you’ve paid down debts or increased your income since taking out your original mortgage, your DTI may have improved, leading to better refinance rates.
How do you know if it’s worth it to refinance?
Refinancing a home loan is not a one-size-fits-all solution. Here are the critical aspects you should consider when deciding if refinancing is worthwhile.
Your current financial situation
Start by closely examining your current financial situation, including your current mortgage terms, interest rate, credit score and debt-to-income ratio. If your credit score has improved or your debt-to-income ratio has decreased since you initially obtained your mortgage, you may qualify for better loan terms and lower interest rates. Additionally, consider the stability of your income, job security and how long you plan to stay in your home.
Your long-term financial goals
Identify your long-term financial objectives, and assess how refinancing can help you achieve them. For instance, refinancing might be right if it enables you to consolidate high-interest debt, invest in home improvements, or save for retirement. Ensure that your decision aligns with your financial priorities and contributes to your overall financial stability.
The costs associated with refinancing
While refinancing can offer potential savings, you must still weigh these benefits against the costs involved.
Refinancing costs may include loan origination fees, appraisal fees, title insurance and other closing costs. Additionally, you may lose certain benefits from your existing mortgage, such as prepayment privileges or rate discounts.
The break-even point
In refinancing, the break-even point represents the months it takes for the monthly savings from the new mortgage to offset the costs associated with refinancing. To calculate your break-even point, divide the total refinancing costs by the monthly savings achieved through refinancing.
Suppose you are considering refinancing your home loan to take advantage of a lower interest rate. The new mortgage will save you $200 per month on your monthly payments. However, the costs associated with refinancing, such as loan origination fees, appraisal fees and other closing costs, amount to $6,000.
Break-even point = Total refinancing costs / Monthly savings,
With the numbers provided above, that means
Break-even point = $6,000 / $200
Break-even point = 30 months
In this example, it will take 30 months, or 2.5 years, for the savings generated by refinancing to cover the costs associated with the process. In this case, refinancing may only be a sound decision if you plan to stay in your home for longer than the break-even point.
However, if you expect to move or sell your home before reaching the break-even point, refinancing might not be the best choice, as you won’t have enough time to recoup the costs.
Is it expensive to refinance?
“Expensive” is subjective. But it’s worth mentioning that refinancing your home loan can come with a range of fees and costs, so you have to understand the expenses involved before deciding.
Standard charges you may encounter when refinancing:
- Discharge or settlement fee. This is a fee charged by your current lender to release your mortgage and finalise the refinancing process. The amount can vary depending on the lender, but it can be as high as $600.
- Application fees. The new lender may charge an application fee to process your refinancing request. This fee covers reviewing your application, conducting a credit check and other administrative tasks. Application fees can range from $0 to $1,000.
- Valuation fee. Your new lender may require an updated property valuation to determine its market value. The valuation fee usually depends on the size of your property and typically ranges from $200 to $600, but some lenders may waive this fee as part of a promotional offer.
- Mortgage registration fee. This is a government fee charged to register the new mortgage on your property title. This fee varies by state or territory but usually falls between $100 and $200.
- Lenders Mortgage Insurance (LMI). If you’re refinancing more than 80% of your property’s value, you may be required to pay LMI. This insurance protects the lender in case you default on your loan. LMI premiums can range from a few thousand dollars to tens of thousands, depending on the size of your loan and the amount of equity you have.
- Ongoing fees. Some loans come with ongoing fees, such as annual or monthly account maintenance fees. These costs can add up over time, so it’s crucial to factor them into your decision when refinancing.
- Break or exit fees. If you’re refinancing a fixed-rate loan before the fixed term ends, you may be charged a break or exit fee. This fee compensates the lender for any financial loss they may incur due to the early termination of your loan agreement. Break or exit fees can vary significantly, depending on the remaining term and the lender’s terms and conditions.
- Additional costs. Other costs may be associated with refinancing, such as conveyancing or financial advisor fees. Make sure to factor in these additional expenses when assessing the total cost of refinancing your home loan.
Does refinancing hurt your credit?
Although the effect is typically temporary and minimal, refinancing your home loan can impact your credit score.
A closer look at the potential effects:
When you apply for a refinance, the lender will perform a hard credit inquiry to assess your creditworthiness. This inquiry can cause a temporary dip in your credit score, usually by a few points. However, the impact is generally minimal and diminishes over time, typically disappearing after 12 months.
To minimise the effect on your credit score, shop around for the best refinance rates within a short period. Credit scoring models often treat multiple inquiries for the same type of loan within a specific timeframe (typically 14 to 45 days) as a single inquiry.
Age of credit history
The length of your credit history, particularly the age of your oldest and most recent accounts, is another factor that influences your credit score. Refinancing involves closing your existing mortgage and opening a new one, which can decrease the average age of your credit accounts.
Your current mortgage will be marked as a closed account on your credit report when you refinance. If the account has a history of on-time payments, it can continue to contribute positively to your credit score for up to ten years from the closure date. However, if there’s a history of late or missed payments, those negative marks can remain on your credit report for up to seven years, affecting your credit score during that time.
If you maintain a good payment history and make on-time payments on your new refinanced mortgage, your credit score should recover from any initial dip caused by the refinancing process. Conversely, missing payments or defaulting on your new mortgage could significantly negatively impact your credit score.
What do you lose when you refinance?
Besides additional fees and the possible effect on your credit score, refinancing can also cost you:
- Time spent on your current loan. When you refinance, you’re essentially starting a new loan, which may reset the clock on your mortgage. If you’ve already made significant progress on your current loan, refinancing could extend your repayment term, causing you to pay more in interest over the life of the loan.
- Equity. Refinancing may require you to pay upfront costs or fees, which can be rolled into the new loan amount. This can reduce your home equity, as you’re borrowing more against your property.
- Fixed interest rate. If you have a fixed-rate mortgage with a favourable interest rate, refinancing to a variable-rate mortgage may result in losing that fixed rate. While a variable interest rate may initially offer lower interest rates, they are subject to change over time, potentially leading to higher payments in the future.
- Loan benefits. If your current mortgage includes special benefits, such as low-interest government loans, grants, or other incentives, refinancing may result in losing these perks. So be sure to carefully review the terms and conditions of your existing loan before proceeding with a refinance.
- Long-term interest costs. Refinancing may lower monthly payments but can extend the life of your loan. This could increase the total amount of interest you pay over time, even if your new interest rate is lower. Therefore, it’s essential to calculate the long-term costs of refinancing.
- Relationship with the current lender. If you’ve built a strong relationship with your current lender, refinancing with a different lender may result in losing that rapport. A good relationship with your lender can be beneficial in terms of negotiating better terms or receiving more personalised service.
What should you not do when refinancing?
Refinancing your home loan is a big undertaking, so making informed decisions is crucial, particularly when it comes to common mistakes. As you do your research, make sure you steer clear of these pitfalls:
Not shopping around
A common mistake when refinancing is not shopping around for the best rates and terms. Lenders can offer different interest rates, fees and loan conditions, and they may employ various marketing ploys to make their offers appear more attractive.
No matter their offer, compare multiple options to find the best fit for your financial situation. Just because a lender offers a lower monthly repayment fee doesn’t necessarily mean it’s the best rate for you.
There may be hidden costs or fees that can make the loan more expensive in the long run. Take the time to request quotes from several lenders, carefully review the loan terms, and compare the offers beyond just the monthly payment amount.
Skipping the fine print
Lenders are eager to have you sign up for their loan products and may offer various promotions, discounts, or other incentives to make their offer appear more appealing. However, these incentives can sometimes come with strings attached or hidden conditions that may not be in your best interest.
Be cautious and read the fine print to understand what they’re asking from you in return. Review details such as prepayment penalties, rate locks, and any additional fees that may not be immediately apparent.
If you’re unsure about any aspect of your new loan, don’t hesitate to ask the lender for clarification.
Overlooking the total cost
Focusing solely on the monthly savings from a lower interest rate can lead to overlooking the total cost of refinancing, including fees, points and the extension of your loan term.
For example, let’s say you refinance your mortgage to reduce your interest rate from 4% to 3.5%, saving you $100 monthly. However, the refinancing process incurs $4,000 in fees, and the loan term is extended by an additional five years. In this case, it would take 40 months to break even on the refinancing costs ($4,000 / $100 = 40), and the extended loan term would result in additional interest payments over the life of the loan.
By factoring in these costs, you can ensure you have a comprehensive understanding of the refinancing costs and make a well-informed decision.
Depleting home equity
Refinancing can sometimes require upfront costs that are rolled into the new loan amount, which can effectively deplete your home equity. Home equity is the difference between the current market value of your property and the outstanding balance on your mortgage.
When refinancing, be cautious about taking on additional debt that could reduce your equity and potentially impact your financial future. Consider paying the refinancing costs upfront instead of rolling them into the new loan if possible. This will help preserve your home equity and provide you with more financial flexibility in the long run.
Rushing the process
We’ve said this before, and we’re saying it again: refinancing is a significant financial decision that should be carefully considered and researched. Rushing the process can lead to mistakes, suboptimal loan terms or missed opportunities for better offers.
Rather than hastily making a decision, take your time to gather information, compare offers, and make an informed choice. Set aside adequate time to research lenders, evaluate loan options, and assess the potential benefits and drawbacks of refinancing.
Not seeking professional advice
Navigating the refinancing process can be complex, and seeking professional advice from a financial advisor, mortgage broker or loan officer can help you make the best decision. This is because professionals have a broader perspective and understanding of the market and can guide you through the intricacies of refinancing.
Whereas attempting to handle the refinancing process without professional guidance can lead to missed opportunities, misunderstandings, or less favourable loan terms, professionals can provide insights into the current market, help you evaluate different loan options, and assist with the application process, ensuring you make a well-informed and financially sound decision.
Get expert advice from Debt Negotiators
Don’t let confusion or uncertainty hold you back from the potential benefits of refinancing your home loan. Our professional team is ready to answer your questions and provide tailored advice. Contact us for a refinancing evaluation or learn more about our debt solutions.