Home loan refinancing is a popular financial strategy that many homeowners use to help them take control of their mortgage and finances. It involves moving from an existing home loan to a new one, and in the process negotiating better loan terms and interest rates to save you money, uncovering new features to save you time, and even unlocking equity for renovations or investments.
But what does it really mean to refinance your mortgage? And where do you start? In this article, we’ll look at what refinancing means, why and when you might consider it, and how to refinance a home loan. We also consider the potential pitfalls and how to avoid them.
So, what is home loan refinancing?
In basic terms, refinancing your mortgage is the process of replacing your existing home loan with a new one.
Sounds easy right? Well, it can be as simple as switching to a different home lender, but it can also involve negotiating with your current lender for better terms. The ultimate goal, however, is to lock in a lower interest rate, access better loan features, or use the equity built up in your property to fund other financial goals.
It’s kind of like a reset for your mortgage. You pay off your current loan using the funds from the new loan and start making repayments under the new terms.
So, what are the options?
Refinancing options
Depending on what you want out of the refinancing process, you can choose from various home loan refinancing options. It’s definitely worth taking the time to explore each one to see what might be best for your particular situation.
Cash-out refinance
This is where you borrow more than your current loan amount and take the difference as cash, usually for renovations or large purchases. A cash–out refinance may also provide an opportunity to take advantage of a new term and a better interest rate.
Refinancing with an offset account
If you have some extra cash or savings, you could refinance your home loan to one with an offset account, allowing you to link the savings to your mortgage. With an offset account, the positive balance of your savings ‘offsets’ your outstanding mortgage balance, cutting the interest you pay and reducing repayments.
Debt consolidation refinance
With a debt consolidation refinance, you roll other debts (like your credit cards or a personal loan) into your mortgage for easier, and often cheaper, repayments. While your debt will increase, you can reduce the number of repayments you’re making so it can be easier (and less stressful) to manage your finances.
Rate and term refinance
This is where you refinance your mortgage to take advantage of a change in interest rate, loan term, or both, without borrowing any extra money.
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Why do people refinance?
Refinancing triggers:
- Interest rates have dropped
- Fixed-rate period is ending
- Improved financial situation
- Unhappy with current lender
- Want to fund a renovation
- Home value has increased
There are several reasons why homeowners choose to refinance. They include:
To lower your interest rate
Even a small drop in interest rates can lead to significant savings over the life of your loan. That’s why one of the main motivators for refinancing is to secure a lower rate. In turn, this could mean lower monthly repayments, and the ability to free–up cash for other aspects of your life as well as decreasing overall financial stress.
To access equity
Equity is the difference between what you owe on your mortgage and how much your house is worth. So, as you pay off your loan and your property value increases, your equity goes up. Refinancing can help you access that equity for other things like renovating, buying an investment property or shares, or to fund education or a new business idea.
To consolidate debt
With a debt consolidation refinance, you roll other debts (like your credit cards or a personal loan) into your mortgage for easier, and often cheaper, repayments. While your debt will increase, you can reduce the number of repayments you’re making so it can be easier (and less stressful) to manage your finances.
To shorten your loan term
Paying off your loan sooner can reduce the total interest paid, so switching home loans to one with a shorter term can help you save on interest.
To switch loan types
Refinancing can help you merge personal loans or credit card debt into your home loan to streamline repayments.
To benefit from better loan features
Newer home loan products may come with better features like redraw facilities, offset accounts or flexible repayment options. Refinancing can help you access these.
Benefits vs Drawbacks of Refinancing
While refinancing your home loan can be a great way to access lower rates or better features, there can also be some risks involved. That’s why it’s important to understand the advantages and limitations of a refinance before you start. We’ve summarised the refinancing pros and cons below:
The Pros
Refinancing can be a smart financial move when done for the right reasons and at the right time. The key benefits include:
- Lower interest rate
- Reduced monthly repayments
- Better, flexible loan features
- Access to equity for investment
- Consolidate debts into one loan
The Cons
It’s important to be aware of the risks to avoid when refinancing to a new home loan. Things to consider include:
- Refinancing costs and fees
- Possible extension of loan term
- Impact on credit score
- Potential reduced equity
- Missing out on further rate drops
A step-by-step guide to the refinancing process
To lower your interest rate
AIM: Understand your existing interest rate, fees, features and loan balance.
This step is not only to work out whether you’re ready to refinance, but also to make sure you qualify for a new loan. Lenders will look at your:
- Current income and employment history
- Credit report, including score and history
- Existing home value and available equity
- Repayment history on your current loan
- Debt obligations
In some cases, it may take time to get these things in order, but once everything is ready, you can move on to step 2.
Set your goals
AIM: Work out exactly what you want to achieve by doing a refinance.
Whether you want lower repayments, faster debt reduction or access to equity, knowing your goals helps you find the right product.
Compare your options
AIM: To get the best deal and features for your situation and goals.
It’s important to find a home loan provider that ticks all your boxes, whether that’s a lower interest rate, a better monthly repayment amount, or flexible features like an offset account. A good place to start is using online comparison tools to explore and narrow your options.
Don’t forget, it’s a great idea to talk to your current lender to see if they can offer a better deal than what you currently have. That way you can avoid the costs of changing to a new provider.
Calculate the costs of refinancing
AIM: Weigh up the costs of refinancing against the benefits.
Once you have found the refinancing option that is right for you, make sure to calculate the costs of changing to that new loan, and compare them to the potential savings or benefits. Costs can add up, and include discharge fees, break costs (for fixed rate loans), application fees and valuation charges.
Apply for the new loan
AIM: To speed up the process by gathering everything you need to apply.
When you apply for a new loan, you’ll need to provide a range of several documents, just like when you applied for your current mortgage. Your lender will let you know exactly what documents they need, it usually includes evidence of your income, assets and liabilities. Things like recent pay slips, tax returns, proof of residency, photo ID and bank statements. You’ll also likely need to undergo a credit check.
Valuation, approval and settlement
AIM: Finalise the refinancing process and kick some goals.
Once the new lender has what they need from you, they will usually organise a property valuation. With that in hand, and if the loan is approved, you’ll receive a loan offer. Once you accept the offer, and after any applicable settlement period, your new lender will pay out your existing loan. Then you’ll start your new repayments under the refinanced terms.
Ready to refinance?
If you’re ready to refinance, speak with a Homestar Finance lending specialists about a refinancing option that’s right for you.
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.
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