Refinancing Your Loan

There’s so much to consider when you’re refinancing your loan and it can feel overwhelming.  We’ve identified nine key stages of refinancing a loan which we’ve found makes the whole process feel more manageable. Each section below describes one of the nine stages in detail.

Stage 1: Why?

It is important you understand WHY you want to refinance. Being clear with your reason will be very helpful in achieving the outcome that you want.

There are many reasons you may wish to refinance and here are some of them:

• Lower interest rate
• Reduced fees.
• Better customer experience.
• Accessing equity from your property for a renovation, investments, or a new car.
• Lower repayments.
• Consolidate several loans.
• New features such as an offset account or redraw facility.
• Restructure of loan – e.g. from investment loan to home loan
• Streamline loan with one lender

 Taking a moment to understand the reason you want to refinance will make it easier for you when you progress to the next stage of the process.

Stage 2: Understanding Your Current Financial Situation

Before you start looking seriously for a new loan, consider your current financial situation to see if you are in a position to refinance your existing loan.

This may come as a shock to you as you previously have qualified for a loan. Surely you can qualify for a loan again. Well, you will be surprised how things can change between obtaining your existing loan and now. Things like, your credit history, your account conduct, your loan affordability and your property value can change over time and these are some things that lenders generally look at when assessing your refinance application. Lets you at them in a bit more detail:

1. Credit History

Lenders will look at your credit history to ensure that you have good credit history. Any adverse credit entry in your credit report isn’t ideal when you are trying to refinance your home loan. While it is still possible to refinance your home loan with bad credit history, your refinance options will be very limited.

2. Account Conduct

Poor account conduct is not the same as bad credit history. Poor account conduct is where you may be late paying bills or debts, but not so late that they have been referred to a credit agency.

Bank also deemed you have poor account conduct if you regularly overdrawn your bank account or your transaction is rejected due to insufficient credit.

Banks are looking at this very carefully to access your ability to meet your future repayment and some banks are now even automatically declining loan applications for people with poor account conduct.

3. Loan Serviceability

Broadly defined, serviceability is your ability as a borrower to meet loan repayments, based upon the loan amount, your income, your employment situation, expenses and other commitments such as credit card debt, personal loans and car loans.

The calculations for serviceability are a bit more complex than merely deducting expenses from income. Lenders in Australia tend to use one of the following methods for calculating serviceability:

• Net surplus ratio (NSR) - This looks at the amount of money that you won’t be using to pay your debt and it expresses this as a percentage of your total after-tax income.
• Debt servicing ratio (DSR) - This method calculates the percentage of income that will be used to pay your debt once the proposed home loan is factored in.
• Uncommitted monthly Income (UMI) – This calculates the income you’ll have available each month after all expenses have been factored in, including proposed home loan repayments.

All lenders differ in how they assess serviceability and the way they work out your maximum borrowing power. However, regardless what the lenders say about your borrowing capacity, you need to be comfortable with your mortgage repayment and avoid “mortgage stress” which is when 30% or more of your income goes on your home loan repayment.

4. Equity In The Existing Home

Equity is the difference between the market value of your house and your home loan balance. It means that you own a small portion of the home.

Lenders use a Loan to Value Ratio (LVR) to assess how risky you are as a borrower. It looks at the amount you wish to refinance in relation to the market value of the house you own. The higher the ratio, the more risky you are as a lender.

Generally, I would suggest that you have a Loan to Value Ratio of 80%.  This means you need an equity of at least 20% of the value of the property.

So, what happens if the loan to value ratio is above 80%?

The reason for borrowing up to 80% of the value of the property and not more is to avoid Lenders Mortgage Insurance (LMI).

LMI is a fee charged by lenders to provide themselves with an extra level of protection in case you can’t pay your loan. It’s not cheap and the more you borrow, the more it costs.

LMI on a $300,000 loan, would cost between $8,000 and $15,000.

If you are willing to pay for LMI, you can usually refinance up to 90% of the property value. However, keep in mind that higher borrowing usually attracts a higher interest rate.

On the other hand, the good news is, if you have a bigger equity and you refinance less than 80% of the value, you may even be able to negotiate a discounted interest rate from the lender.

Taking a moment to understand your financial situation will make it easier for you when you progress to the next stage of the process.

Stage 3: The Cost vs Benefit of Refinance

Refinancing your loan can be a smart way for you to reduce your loan repayments or pay off your loan quicker. However, there may be some refinance cost that you need to consider. You need to weigh up the short term pain for the long term gain. To make sure that you are not caught off guard, we have listed some common fees and charges to look out for when refinancing. It is best to check with lenders or your mortgage broker in case we miss some upfront cost here.

Loan Application

This is a fee the lender charges when you apply for a loan. It can also be referred to as an establishment, up-front, start-up or a set-up fee. Fees vary depending on your provider and will cover things such as credit checks, property valuation and basic administration costs. Some lenders will waive this fee under certain circumstances, so it’s worth asking.

Property Valuation Fees

Most lenders will request that your property be valued by an independent valuer. The cost can vary between $250 to $600 per property.

Mortgage Registration

Mortgage registration apply when you are refinancing your property and the costs differ from state to state. Mortgage registration fees are usually in the hundreds of dollars. Each revenue office website has online calculators for you to work out the government fees associated with transferring a mortgage.

Legal, Settlement and Handling Fees

Some lenders charge legal, settlement and handling fees for your loan. This is a cost of preparing loan documentation for your application and legal fees to process the loan documentation.

Break Cost

Break cost applies if you refinance your fixed rate loan before the end of the loan fixed period. Break cost is charge because lender will make financial loss if you break a fixed term loan.

Break costs can be significant and are calculated based on the length of time remaining on the fixed term, current market interest rate and the loan amount. So, it is best that you speak to your current lender and find out the estimated break cost if you wish to refinance a fixed rate loan.

Lenders Mortgage Insurance

If you are refinancing a loan and have not accrued 20% equity on your current loan, you may also need to pay Lender’s Mortgage Insurance (LMI). This cost can be quite significant. So before choosing to refinance, make sure that you have 20% equity on your property.

Benefits

The main benefits that you get from refinance is lower interest rate. You need to work out the savings that you will be getting from lower interest rate. The simplest way to do this is to work out the difference between your current loan repayment against the new loan repayment. Make sure that the term of the loan term remains the same. If the loan term is extended, say from 15 years out to 20 years, no doubt that your monthly repayment will be lower, but you will be paying more interest in the long run.

For example, if you are paying $2,000 to refinance your loan and you will be saving $50 per month, it will take you at least 40 months to reach the breakeven point. You need to weigh up if this is something that will be beneficial for you.

Stage 4: Talk to Your Current Lender

Before you engage in serious discussion with other lenders, it is worthwhile talking to your current lender to see what they can do to keep you. Generally, it is easier for lenders to retain existing customer rather than trying to look for new client. Here are some benefits of doing this:

• Quick and Easy – Your current lender already has your details and know your repayment history

• Avoid Paying Refinance Fees – Refinance cost can be quite significant

• Save Time and Paperwork – Refinance process from start to finish can take up to 2 months. There is also numerous paperwork that you need to provide and prepare for new lenders

• Room for Negotiation – Lender will try and do their best to keep you as a customer especially if you also have your day to day banking with them

If you think that you only have a small loan and you are not important to your current lender, think again.

If your loan balance is $300,000, your interest rate is 3% and you have 25 years remaining on your loan term, the potential loss to the lender will be close to $130,000 in interest revenue.

Stage 5: Talk to a Mortgage Broker

Approach a mortgage broker who will have access to loan products from many banks and non-bank lenders some of which are only available through brokers.  A good mortgage broker will be able to shop around for you to find the best rates and lower fees from the products they offer. 

Many mortgage brokers will meet you at a time that’s convenient for you such as after hours or on weekends and some will come to your home.  Mortgage brokers are experienced in the home buying process and can offer you advice and suggestions throughout the process.

Before you meet, check if the mortgage broker charges a fee for service, as some do not.  Many mortgage brokers are paid by commission only. On the surface, this may look like a conflict – i.e. a broker will choose a lender that pays them a lot of commission. However, in reality the commission rate between lenders did not vary greatly. Where there is a difference, it is not worth for a broker to recommend a lender with higher brokerage purely based on the commission received as the hassle that it will cause is not worth the extra commission. Lenders must recommend a loan product that suit your requirements and need to disclose the commission that they received from a lender in writing.

You can do the shopping around and decide which bank and which product you want.  Remember, the representative at each bank will only have information about the products they offer so you’ll have to do the comparison research yourself. This can be a lot of work, and you’ll be limited to banking hours. 

Stage 6: Property Valuation

Getting property valuation done prior to refinance is important to ensure that you have enough equity in your property. You want to make sure that you have at least 20% equity in your property. Otherwise, you will be required to pay lenders mortgage insurance (LMI). This will add considerable cost to your refinance.

Getting an appraisal from a real estate agent is different from getting a property valuation. An appraisal is not a legally biding document and cannot be used when you apply for refinance. While both determine the market value of your property, a valuation is undertaken by a professional valuer who is appointed by a lender.

Valuers are professionals who evaluate your property on predetermined principles and guidance, providing an unbiased view of the property’s worth to the lenders. In general, a valuer looks at the property type and size, it’s age, condition and geographical locations. Zoning restrictions also affect the overall value of a property.

Following tips may potentially help with the value of your property:

• Ensure that the property is well presented
• Introduce plenty of storage space in the house
• Keep the house and lawn clean and clutter-free

Some lenders offer free valuation through a mortgage broker prior to you refinancing your loan. Some lenders provided paid valuation option prior to you refinancing your loan. If none of these options available, you could obtain appraisal from a few experienced local real estate agents and determine the average value of the house to make informed decisions.

Stage 7: Apply for New Loan

Once you are ready to refinance, the next step is to prepare for your refinance application. When refinancing, lenders will be looking for the same things you had to provide when you applied for your existing loan. Most likely you will be required to provide more information due to government additional legislations.

There are hundreds of home loans available, with new products emerging all the time. The main types of home loans, which form the basis of all the new products, are: variable loans, fixed loans, split loans, interest only loans and low documentation (low doc) loans.

Here’s a snapshot of the main types of home loans available for your to choose from:

Variable Loans

Standard variable loans are the most popular home loan in Australia. Interest rates go up or down over the life of the loan depending on the official rate set by the Reserve Bank of Australia. That means that if interest rates fall, then your loan repayments will go down. It also means that if interest rates go up, your loan repayments will increase according to the official interest rate.The Reserve Bank of Australia meets every month to decide what to do about interest rates depending on the world economy and Australia’s economy. Often they leave it unchanged. It rises or falls by half a percent at a time, so a rise in interest rates is a slow and gradual process. Even so, be prepared for the difference that a rise in 2 or 3% could cause to you in your loan repayments.In a standard variable loan your regular repayments pay off both the interest and some principal.Many standard variable loans allow you to make extra repayments to your loan, so you can pay it off faster.Some standard variable loans have a redraw facility. This means that if your make any additional payments to your loan you can take that money out again if you need to.  If you get a bonus payment on your tax return, for example, you can put it into your redraw facility.  In the redraw facility that extra money is paying down your loan.  If you ever need that money for any reason, you can take it out and use it. There are also basic variable loans which may have a lower interest rate but not offer the benefits of repayment flexibility and a redraw facility.

Fixed Loans

In a fixed loan the interest rate is fixed for a certain period, usually between one and five years. This means your regular repayments stay the same regardless of changes in interest rates. At the end of the fixed period, you can decide whether to fix the rate again, at whatever rate lenders are offering at that time, or move to a variable loan.The benefits of a fixed loan are that it’s easier to manage your household budget because you know exactly how much you need to repay your home loan.  You won’t be affected by changes in interest rates at all, whether they go up or down.A fixed loan may have restrictions on the amount of extra repayments you can make during the fixed period of the loan and if you exit the loan early you may need to pay a fee.

Split Rate Loans
Your loan amount is split, so one part is variable, and the other is fixed. You decide on the proportion of variable and fixed. You enjoy some flexibility of a variable loan along with the certainty of a fixed rate loan. 

Interest Only Loans

You repay only the interest on the amount usually borrowed for the first one to five years of the loan. Because you’re not paying off the principal, your monthly repayments are lower. At the end of the interest-only period, you begin to pay off both interest and principal. These loans are especially popular with investors who plan to pay off the principal when the property is sold. This is not something that I would consider suitable for first home buyers.

Low Doc or Low Documentation Loans
Popular with self-employed people, these loans require less documentation or proof of income than most, but often carry higher interest rates or require a larger deposit because of the perceived higher risk for the lender. In most cases, you will be financially better off getting together full documentation for another type of loan.

You also need to work out what type of loan feature you want for your home loan. Some of the most common features are:

Extra Repayments
If you pay more than the required regular repayment, the extra amount is deducted from the principal. This reduces the amount you owe and lowers the amount of interest you repay. Making extra repayments regularly, even small ones, is the best way to pay off your home loan quicker and save on interest charges.

Weekly or Fortnightly Repayments
Instead of a regular monthly repayment, you pay off your home loan weekly or fortnightly. This can suit people who are paid on a weekly or fortnightly basis and will save you money because you end up making more payments in a year, cutting the life of the loan.

Redraw Facility
This allows you to access any extra repayments you have made. Be aware that some lenders charge a redraw fee and have a minimum redraw amount.

Repayment Holiday
If you pay extra into your loan, you can take a complete break from repayments, or make reduced repayments, for an agreed period of time. This can be useful for travel, maternity leave or a career change.  For example, if you pay 3 months of your regular repayments in advance, you could arrange to make lower repayments for the next 6 months.

Offset Account
This is a savings account linked to your home loan. Any money paid into the savings account is deducted from the principal of your home loan before interest is calculated. The more money you put in your offset account, the lower your regular home loan repayments. You can access your savings just like a normal savings account with EFTPOS and ATMs. This is a great way to reduce the interest on your loan.Another bonus is that if you use the offset account instead of a savings account you won’t have to pay tax on your savings.Lenders provide partial as well as 100% offset accounts. Be aware that having an offset account may mean your loan has higher monthly fees or requires a minimum balance.

Direct Debit
Your lender automatically draws repayments from a chosen bank account. Apart from ensuring there is enough cash in the account, you don’t have to worry about making repayments.

All-in-One Home Loan
This combines a home loan with a cheque, savings and credit card account. You can have your salary paid into it directly. By keeping cash in the account for as long as possible each month you can reduce the principal and interest charges. Used with discipline, the all-in-one feature gives flexibility and interest savings. Interest rates charged on these loans can be higher.

Professional Package
Home loans over a certain value are offered at a discounted rate, combined with discounted fees on other banking services. These can be attractively priced, but if you don’t use the banking services you may be better off with a basic variable loan.

Stage 8 – Finalisation and Settlement

Finalisation

When your refinance is approved by the new lender, they will get in touch with you to welcome. They generally will guide you through the process by helping you setup your new bank account and your internet banking.

At this point, you need to notify your current lender that you are going to refinance your home loan to another lender. You need to complete a “Mortgage Discharge Form” and forward it to your current lender.

Settlement Day

On Settlement day a number of exchanges occur between your current lender and new lender (you don’t need to be present).

Here is a rough outline of what happens:

• Your new lender pays the balance of your current loan to your current lender
• Your current lender will discharge the mortgage on your property and will pass it on to your new lender. The new mortgage will be noted on the title until the term of the home loan is completed. When you’ve paid off your mortgage you get to keep the title, until then it belongs to your new lender. 

Be warned, that it is not unusual for settlements to be delayed by a few hours, or even a day or so due to a variety of factors like a missed signature, a cheque being delayed or incorrect paperwork.

Although it is an extremely frustrating, everybody will be working to effect settlement as soon as possible for you.

Stage 9: Where to From Here

Update Your Home Budget & Continue Saving

You’ve done a great job with your budget!  You’ve successfully refinance and you now have lower loan repayment.

Keep saving!  It’s so important to have savings there in case of some kind of emergency. You can keep your savings in a redraw account or an offset account so your savings are working on your mortgage.

Make extra repayments

You the savings to make extra repayment on your loan. Making extra repayments on your loan is hugely worthwhile:

Extra repayments reduce the principal amount of your loan and so that decreases the amount of interest you need to pay.  Not only that, because you’re paying more, the time period of your loan will also decrease and you’ll fully own your home sooner.

Most lenders allow extra repayments on home loans, and they also let you access those funds if you ever need them. This can be using a redraw facility or an offset account. 

It also gives you a buffer in case you may accidentally make a late repayment.

If you have a home loan or other personal debt, pay down the other loan first as the interest on your investment property is tax deductible.

Avoid New Debt

Avoid taking on new debt, if you can help it. Think very carefully before you take on any new debt like a new credit card or a personal loan.  Make sure you can afford it and that it is for something really worthwhile.

Not long after someone refinance their home loan, they often come in to see us about getting a loan for a new car.

We do our best to talk them out of it!

A car is a depreciating asset.  It’s losing value every single day you have it. To be honest with you, if you can’t afford the car you want, a car loan is a bad financial decision. You’ll be paying interest on the loan and the car will be losing value. You’re losing money in two directions.

You may want to consider buying a second hand car that will do the job in the interim while you save to buy the car you really want with cash.  You’ve successfully saved a deposit for your property, so what can stop you?

Personal Insurance

There’s no telling what the future holds and it pays to be prepared.

How would you pay your bills and your home loan if you could no longer work?  Do you have the right protection in place?

There is no set amount of cover that you should have. You need to make a sound estimate of your current financial situation and imagine what you and your family will need if you can no longer provide regular income.

Given the complexity of the matter, you should speak to a financial adviser to make sure you’ve covered everything important and have the right cover for you and your family.

Here’s a snapshot of what you should consider:

Life Insurance
Life insurance is a lump sum paid to your family (or your estate) when you die.

Consider a life insurance policy that, at a minimum, accounts for the value of the home loan. That way if tragedy strikes, you know that whoever is left behind doesn’t have the additional worry of how they are going to pay off the home.

If you a have a superannuation fund, it will have a life insurance component or a death benefit. The amount will be adequate in some situations, but it is well below the needs of families with dependent children. You may be able to increase the amount by paying extra into your super fund, or you may think about taking out a separate life insurance policy.

Take into account your partner’s working capacity. If you have insufficient life insurance, chances are they will have to work to help make ends meet.

Stay-at-home partners also should have some level of cover. If the stay-at-home parent were to pass away, the current income earner may need to spend more time at home with children and have less capacity to earn.

Total and Permanent Disability (TPD) Insurance
Total and permanent disability (TPD) insurance covers the costs of rehabilitation, debt repayments and the future cost of living if you are totally and permanently disabled. It is usually bundled together with life insurance. Check if your super fund offers TPD cover and whether this amount would realistically cover your family’s needs if you were unable to work again.  Often you can opt to increase the TPD and life insurance benefit in your super fund by paying extra.

Income Protection Insurance
Income protection insurance covers up to 75% of your usual income if you can’t work for an extended period due to injury or illness. It is more comprehensive than workers compensation which only covers injuries that are work related.

Premiums vary, depending how much cover you need and are generally tax deductible (please confirm with your accountant). As with most insurance products, premiums increase with age because you are more likely to make a claim. Some products, however, offer level premiums where you always pay the same amount.

Many policy holders reduce their premiums when their children get older and need less support. You can also save on premiums by taking out a policy with a six-month waiting period before you can claim.

Trauma Cover
Also known as critical illness cover, this provides a lump sum payment if you are diagnosed with a specific serious illness, such as cancer or stroke. There are about 45 diseases that fall into this category for insurance purposes depending on the insurance company. If you have a family history of a serious illness, it would be worthwhile getting trauma cover.

Prepare Your Estate Plan

Like insurance, estate planning is about preparing for the worst while hoping for the best.

It’s a responsibility you have to your family.  If you become incapacitated or die, you need to have plans in place. 

Making a Will is one of the key tasks of estate planning. It is about deciding what will happen to your assets, when you die.  Your will provides instructions on how your estate is to be distributed amongst your nominated beneficiaries.

With regards to your home, if you own your properties as tenants in common, you are able to pass on your share in the property in your will.

If you own the property as joint tenants, on your death, the surviving co-owner will automatically become the sole owner of the property. However, if both you and your co-owner die at the same time the property can be passed on according to your will.

A thorough estate plan includes a will and:

Power of Attorney
Where you appoint someone else to conduct your affairs if you are unable to do so.

Power of Guardianship
Where you give someone else the power to make personal and lifestyle decisions for you if you lose your mental capacity.

Advance Health Care Directive
Which are Instructions on your wishes regarding medical treatment if you’re unable to communicate.

The key when making your estate plan is to be as specific as possible about your intentions. It may be uncomfortable contemplating your own passing, but it ensures legal battles are not part of your legacy.

Speak with a lawyer so that your estate plan is tailored specifically to your needs, your goals, and your family situation. General strategies, such as do it yourself will kits can be very helpful as springboards to a tailored plan, but they may not cover everything in your situation.

WE’RE HERE TO HELP YOU

Dealing with banks can be a stressful experience but rest assured that our mortgage broker based in Glenelg (but our mortgage broker services the entire Adelaide Metropolitan area) can help you make the right decision about your mortgage. We will guide you at every stage of your loan process.

Contact us on 08 8376 0455 or drop into our office at 593 Anzac Highway, Glenelg SA 5045.

Any advice contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. Information in this article is correct as of the date of publication and is subject to change.