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Refinancing is simply the process of taking your home loan debt and moving it to another bank or lender.
If you can refinance your mortgage to a cheaper interest rate, you can save money on your monthly repayments or even own your home outright years sooner.
Here’s how it works.
What is refinancing?
Refinancing is exactly what it sounds like: it’s the process of taking your finance arrangement and “re” doing it with a whole new lender.
You can apply for a new loan directly with a new lender, or through a mortgage broker.
In the past, refinancing was often time-consuming, involving multiple in-person meetings, trips to the bank, visits to sign the paperwork, and endless searches for supporting documentation.
These days, advances in technology have made refinancing far more simple.
You can often do it online, and many aspects have been streamlined and digitised.
For instance, some lenders have the technology to automatically “talk” to your employer or the tax office, making it easy to quickly and accurately verify your income.
When you apply to refinance, the lender will assess your application and run a credit check.
Your credit file is like your money resume — it demonstrates to the bank how reliable and responsible you are with money.
The better your credit score, the better your odds of getting home loan approval.
The lender may also ask for a valuation on your home, to make sure your refinance amount isn’t too high and to establish your loan to value ratio (LVR).
If your loan is approved, you’ll sign new mortgage documents, and once the refinance settles, your debt officially moves to the new lender.
The new lender pays out your existing loan and takes over the title deed to your property.
If you’ve borrowed any extra money during the refinance, those funds will be deposited into your bank account for you to access on settlement day.
How can refinancing save you money?
If you refinance to a new loan with a new, lower interest rate than you’re currently paying, you’ll immediately start saving money.
And here’s the thing: it’s almost guaranteed that some bank, somewhere, is offering a lower rate than you’re currently paying.
The trick is making sure they don’t charge whopping fees that cancel out the benefit of the rate reduction (and of course, making sure you qualify for finance with them).
Many banks even offer a “cashback” as an incentive, to encourage you to refinance.
I refinanced just before Christmas and my new bank gave me $3,000 to entice me across.
The fees to refinance were about $800 in total, for a couple of government fees worth $197.50 each, and a break fee when I ended my existing fixed-rate loan.
This $3,000 cashback deal meant I was $2,200 ahead before I even calculated the interest savings.
Here’s a quick example to show you how refinancing can save you money
Let’s say you have a principal and interest home loan worth $650,000 and your variable interest rate is 2.79%.
You can refinance to a 3-year fixed rate loan for 2.19%:
- Current repayment at 2.79% = $2,668
- New repayment at 2.19% = $2,465
- Difference in interest rate = 6%
- Difference in monthly repayment = $203
- Savings over 12 months = $2,436
- Savings over 3 years (the fixed-rate period) = $7,308
What if you already have a fixed-rate home loan?
It can be harder to break a fixed-rate loan to refinance, but it’s by no means impossible.
In fact, my refinance I mentioned earlier involved breaking an existing fixed-rate loan, to lock in a different, better deal.
I was previously 12 months into a 2-year fixed-rate at 2.19%.
I broke my current fixed-rate loan and the fee to break was quite small, around $300.
I locked into a new 3-year fixed rate with a new bank at 1.98%.
This new loan takes me through to Christmas 2024.
By then, it’s forecast that interest rates will be 1–1.5% higher than they are now, so I’ve hopefully locked in a great deal!
How can refinancing help you own your home sooner?
In our example above, I’ve shown you how refinancing can save you money.
But you can also use it to help you own your home sooner.
Once again using the above figures, let’s say you don’t pay the new, lower home loan repayment.
Instead, you keep your repayments at the existing amount.
That $203 you’re saving in interest, is now going towards the loan principal each month.
You’re not actually paying any more money than you pay today.
But because you’ve locked in a lower rate loan and you’ve kept your repayments the same, you’re paying an extra $2,436 per year towards your home loan balance.
Our calculator shows that in the above example if you started doing this 2 years into your 30-year loan term, you’d own your home outright almost 3 years sooner by using this strategy.
It’s a relatively easy and effective way to get off the property ladder sooner, and it doesn’t require you to dig any further into your own money.
How often can you refinance?
As often as you like! I’ve actually refinanced twice in the last 18 months, and I’ve received 2 cashback in the process — the first was worth $4,000 and the second was worth $3,000.
While there’s no real limit to how often you can refinance, it can impact your credit file if you have too many inquiries (or applications for credit).
The general rule of thumb is that you should review your existing home loan every year or two, to make sure you’re not paying too much.
If it’s been more than 2 years since you took out your mortgage then there’s a decent chance you’re paying more than you need to.
Shopping around is easy and can save you thousands of dollars.
Also keep in mind that if you can find a better deal elsewhere, you can also approach your existing lender to ask whether they’ll match it on your existing loan.
This can be a really effective way of reducing your interest rate and paying less for your loan, with very little effort involved.
In fact, it could be the most profitable phone call you make this year.
ALSO READ: The RBA is well ahead of its forecasts, so can we expect the same for the property market?
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