Refinancing Your Home Loan

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.

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.

Next Stages

Stage 3: Cost vs Benefits of Refinancing

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.