If you have done your research, you may already have decided that refinancing is the right decision for you.
Refinancing your home loan could help you find a better interest rate and save you money in the short and long-term. You may be able to consolidate debt into fewer payments, and depending on your loan terms, make additional repayments or access redraw when you need.
Here is a step by step guide on how to refinance a home loan.
Overview: How to refinance
The refinancing process may feel a little daunting at first, but here we’ve broken it down into five key steps for you:
- Step 1: Understand the fundamentals of refinancing a home loan
- Step 2: Evaluate your current position, including your lender and existing home loan
- Step 3: Compare home loan options
- Step 4: Apply for your new home loan
- Step 5: Exit your old home loan
Step 1: Understand the fundamentals of refinancing a home loan
Refinancing may be a term you’re very familiar with, or you may associate it with obligatory news mentions whenever interest rates are brought up.
If you’re a homeowner or even just weighing up applying for your first home loan, it’s important to know if refinancing can benefit your specific financial situation.
If you already have a good understanding of the fundamentals, skip through to step 2.
Or, have a look at the full overview here.
What is refinancing?
Refinancing involves trading your existing mortgage for a new one in order to offset the loan balance or reduce the loan term. It involves taking out a new loan for the purposes of paying off your existing mortgage.
As counterintuitive as this may seem, there are a myriad of reasons why refinancing has become universally acknowledged as the ideal way to optimise your mortgage.
Refinancing your home loan is usually done to leverage lower interest rates to reduce interest repayments, or a recent increase in liquidity to shorten your loan contract. Additionally, refinancing can provide more flexibility to the homeowner in other ways, such as a cash-out that can help you to secure more capital without taking out a new loan.
How does refinancing work?
There are generally 3 types of refinancing, though options may vary across different home loan specialists, as well as your own financial situation.
The main three types are as follows:
- Rate-and-Term Refinance Loan: Can be to change the loan term, loan type and/or interest rate
- Cash-Out Refinance Loan: Take out a greater loan amount to withdraw the difference between your existing loan and new loan in cash
- Cash-In Refinance Loan: Use newly available liquidity to take out a new loan at better rates
Once you’ve decided upon the type of refinancing that makes sense for your circumstances, it’s best to assess as many possible options available to you, as well as the costs associated with terminating your current loan. Then, all that’s left is to go ahead and apply.
Can I refinance my home loan?
Most of the eligibility criteria for refinancing involve timing, the terms and conditions provided by your current lender and the equity available to you.
The primary question is “How long have you been locked in with your current lender?” In most cases, if you have been under contract with your current provider for less than 12 months, the break costs and other exit fees may counteract any benefits from reducing interest rates or your loan term.
How much equity do I need to refinance?
The next indicator for eligibility is equity. When you refinance your home loan, it’s optimal to have at least 20% equity in your property. Although this isn’t necessarily a minimum requirement, it’s the industry standard and if your equity falls below the mark, you’ll need to take up LMI (lenders mortgage insurance). Unfortunately, LMI is costly and even if you’ve paid LMI on your current mortgage, it typically does not carry over when you refinance your home loan.
Know why you are refinancing
Finally, but most importantly, you need to know exactly why you are refinancing. Get clear on why you’re switching home loans and nail down the comparative advantages of the new loan.
Common reasons for refinancing include:
- Leveraging better interest rates
- Shortening the loan term
- Changing the loan type (fixed interest rate to variable interest rate and vice versa)
- Accessing the equity in your property
Though all of these reasons are valid, it’s vital that you nail down the opportunity costs of refinancing so that you can make the most of the options available to you. It doesn’t have to be rocket science either; our refinance calculator can help scout out exactly how much you can save.
Step 2: Evaluate your current position
Once you have a good idea of what refinancing is and how it works, consider your current financial position, lender, and home loan repayments.
Consider your current financial situation
Though refinancing can be a great financial trump card when it comes to reducing your monthly repayments or shortening the term, constantly switching loans can be a slippery slope to accruing unnecessary debt.
This is particularly the case if you’re refinancing to tap into your equity. For instance, if you are opting for a cash-out refinance to consolidate other personal debts such as credit accounts or car loans, you need to budget and control the money carefully to prevent any overspending.
Even if it’s refinancing for the purposes of reducing your loan term, you may not be able to recoup the costs if you don’t intend on staying at the property for a long time.
Bottom line; just make sure you consider how financial commitments and long-term plans will affect your savings overall.
The 3 Ps of lending:
The 3 Ps are the main considerations that lenders take into account when approving any form of loan and are a good way to self-analyse your capacity for refinancing prior to application.
- Purpose: Refers to how you intend to use the loan. For instance, if you’re applying for a cash-out refinance, will the money be used for home improvements, consolidating loans or other asset purchases? The lender will also consider the current economic climate and real estate market and any industries that may be contextually relevant to your circumstances.
- Person: Loan providers will examine your loan against your personal credit history. Even if you hold an appropriate amount of equity in your property, you may still be refused for a refinance if you have significant outstanding loans against your name. Personal character is also a strong indicator of responsibility and as such, certain lenders may ask for references as well.
- Payback: Measures your ability to make loan repayments on time. This ability is measured by several factors, the main ones being your cash flow, payment history and the contingent availability of liquid assets in case payments cannot be met.
Understanding how much you can borrow and the Loan to Value ratio (LVR)
Simply put, LVR is the value of your home loan as a percentage of the overall property value. For example, if your home loan amount is $600,000 and your home is worth $950,000, then your LVR would equate to roughly 63.2%.
Though this is more applicable to those applying for their first mortgage, if you are taking out a higher loan when refinancing it is worth noting that most loan providers have a maximum LVR of 90%. As we mentioned earlier, however, LVR over 80% will result in you paying LMI, so it’s best to aim for at least 20% equity.
Though 90% LVR is technically the maximum you can borrow, most lenders will also take your borrowing power into consideration. Borrowing power is calculated by taking your income and expenses into consideration alongside the loan contract you’re considering. If that sounds complicated, our borrowing power calculator can help you iron out some of the details to give you an indication of how much you can borrow.
Look at the cost of your current home loan
When considering your current position, look at how much you’re currently paying. Your interest rate should be listed on your home loan statement, in your online banking (if applicable), or in the home loans product section of your lender’s website. You can also call your lender to find out directly.
Additionally, make sure you find out about any ongoing or annual fees you’re paying as well. These will factor into your calculations when you work out how to get yourself a better deal.
At times, it’s fair to say that taking advantage of payment options on your current loan may be more beneficial to your situation. By utilising our free-to-use home loan offset calculator and extra repayments calculator, you can get familiar with the opportunities to save money or pay off your loan sooner with your existing lender.
Talk to your current lender about a better deal
An often overlooked step in the refinancing process is talking to your current lender about getting a better rate. This should always be one of the first steps before seeking out a different lender since most lenders are determined to keep you. In fact, they have entire teams devoted solely to customer retention because as the old saying goes, acquiring a new customer costs five times more than retaining an existing customer.
While you might not have thoroughly researched all your home loan options at this point in the refinancing process, it is good to have an idea of some of the rates on offer. If you can quote some comparison rates, it can bolster your bargaining power during negotiations.
Examine exit costs or break fees
As discussed, there are always costs associated with leaving your current lender. The discharge fee usually isn’t more than a couple of hundred dollars, but this may depend on how long you’ve been in contract with your current provider.
If you’re on a fixed rate home loan, you’ll need to check the break costs for leaving your loan before the term is over. These can run into the tens of thousands, but could be as low as a few hundred dollars – and may include outstanding premiums for LMI. The best way to find out is to simply call your lender and ask.
Step 3: Compare home loan options
Now it’s time to take some real action and start comparing some of the best rates on the market. Right away, you’ll probably find a number of lenders with significantly cheaper home loan rates than you’re currently paying. But once you take a closer look at the fine print, all may not be what it seems. It’s important to compare beyond just the interest rate, make sure to pay attention to the following factors in particular:
- Fees. High annual or ongoing fees could eat into the value you get from a new lender. To get an idea of whether the fees associated with a new lender are too high to make refinancing a good idea, take a look at the comparison rate. The comparison rate takes into account fees and charges, along with the interest rate.
- Features. Remember to compare home loan features, since some of them can help you shave years off your home loan. Some features you might look for would be an offset account, redraw facilities and split facilities.
- Fixed vs Variable interest rate. A fixed rate mortgage provides a guarantee of what your repayments will cost over the loan period. A variable loan provides more flexibility to make extra repayments when you like, and saves you interest with an offset account. If you decide to choose a split loan, you have the option to do both
- Flexibility. A good mortgage offers flexibility and lets you manage your home loan in the way that’s best for your specific circumstances. Some of the flexible options you might want include extra repayments, more flexible repayment frequency (weekly or fortnightly) and loan portability.
Look at costs of moving to a new lender
Once you’ve looked into the rates, fees, features and flexibility of different home loan products and narrowed down your search, it’s time to weigh up the cost of switching lenders. You’ll want to look at the up-front costs of moving to your new lender, as there can be a few common up-front fees you might be asked to pay (such as an application fee, a settlement fee or a valuation fee).
When you’re looking into these fees, also pay attention to any promotions lenders are running. There may be special deals where home loan lenders will waive fees for refinancers, or even offer to pay clients some of the costs associated with leaving their current lenders. Once you’ve worked out the costs of leaving your current lender and the costs of moving to your new home loan lender, you should have a good idea of how much you’ll save by switching.
How to compare your options
When you want to compare home loans, there are generally three ways to go about it. None are better than the other and we recommend that you use a mixture of all three methods.
As mentioned, enquiring directly can be a good way to negotiate with your current lender, but you can also leverage your improved loan terms when negotiating directly with other lenders. Homestar Finance makes it simple for new customers to enquire directly because we are confident that we have the most competitive and attractive rates in the market.
Use comparison sites
You can also utilise the multitude of different comparison sites available online to get a better idea of what’s out there in the current market. Just make sure to consult multiple sources, as some comparison sites may be involved in promotional marketing.
Use a broker
Consulting a mortgage broker is the most costly of these methods, but they can help you streamline the entire home loan process and can also provide you with personal advice as well. Discussing your options with a professional financial advisor can also provide you with a better understanding of the other options available to you.
Step 4: Apply for your new home loan
Now that you’ve found the home loan that’s going to give you the best deal and the biggest savings, it’s time to apply.
Different lenders will have different application processes and credit criteria, with some taking place entirely online and some requiring you to mail forms and documents. In general, though, there are a few details you’ll need to have ready:
- Personal information. You’ll need to provide your name, date of birth and contact info. Also, you’ll be asked to produce a valid ID, such as a driver’s licence, Medicare card or passport.
- Financial information. You must provide details of your employment, income, assets and liabilities. Lenders will want documentation on this, so you’ll need to have payslips and bank statements ready.
- Loan information. Details of your current home loan are required, so your lender can see your repayment history and outstanding loan amount.
- Property information. Your new lender will need details about your current property. They’ll want to have a valuation done to assess its current value so they can determine how much to lend you.
Approval and settlement
Once you’ve applied, the approval process generally may take up to 10 business days – depending on the information provided, credit approval and your personal financial circumstances.
Step 5: Exit your old home loan
This is the easiest part. Your new lender will communicate with your old lender to discharge you from your old home loan. They’ll exchange all the necessary documentation and take care of things like the title transfer for you.
Once this is done, your new home loan will reach a stage called settlement. This is when the actual funds are disbursed to pay out your old home loan. If everything goes according to plan, you should be able to get from application to settlement within a couple of weeks.
And that’s that. Congratulations! You’ve successfully refinanced your home loan. Now just make sure to do a health check on your home loan roughly every 18 months to make sure you’re still getting a good deal. The refinancing process can take a bit of time and research, but it can potentially save you up to tens of thousands of dollars in the long run.
Frequently asked questions
Enquire today to find out more
If you’re looking for more information more tailored to your personal situation, you can always consult our loan specialists at Homestar Finance to compare rates, seek advice or check eligibility.
Disclaimer: This article is not intended as legal, financial or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature you should seek advice from a qualified and registered Australian legal practitioner or financial or investment advisor.