In many cases people are able to save substantial money by completing a refinance, especially thanks to some good cash back offers available at the moment and lower introductory rates with competing banks. Though despite eight consecutive months of interest rates rises and increases in home loan repayments not all mortgage holders should be refinancing right now.
Here five reasons it may not be a good idea to refinance a home loan.
You are currently on a fixed rate
If you are currently on a fixed interest rate then refinancing is probably not going to make sense. The banks charge what’s called a break cost if you end your fixed rate contract before the expiry date. This fee can run into the thousands (sometimes tens of thousands) and negate any savings you may have otherwise made. There is very complicated formula the lenders use to calculate this break cost and takes into consideration things like interest you would have paid and the cost of funding the loan.
One important thing to note is that when your fixed rate ends, you should always check what variable rate your loan defaults to. This will almost never be the banks best offer and you can definitely take the opportunity to negotiate a lower option with them or to take your business to another lender.
Your LVR is over 80%
If the LVR (loan-to-value-ratio) on your loan is higher than 80% then it can be a bad idea to refinance. This can happen if you’ve redrawn on the loan or the value of the property has gone down at a rate faster than you have paid the loan off. If you refinance and your LVR is over 80% then you will have to pay Lenders Mortgage Insurance which can be very expensive.
If refinancing means substantially extending the loan term
Even though the repayments might be lower, if completing a refinance means you are resetting your loan term from 20 years back to 30 years, then you are going to be paying significantly more over the extra ten years – that’s ten more years of interest you’ll be up for! In the first ten years you generally pay a lot more interest and less principal (i.e. the loan balance) whereas the back half of the loan term you pay down the principal more substantially.
Having to pay high fees
Bit of a no brainer and probably not a major concern for most people right now, but if the switching fees (new application fee, discharge fee on the old loan, etc.) are going to be more expensive than the savings then don’t do it. Another reason you may not want to refinance is if the savings are very small relative to documentation and effort required to complete the change – a few hundred dollars over a year may not feel worth having to put together a loan application again.
A drop in borrowing power
With the recent rate rises from May through to December 2022 the average max borrowing power has dropped by around 25%. This is a huge decrease. You may find you actually can’t refinance your loan if your borrowing power has dropped below your current loan amount. If when you took the loan out originally you were borrowing right at the top of your maximum borrowing capacity and haven’t paid much of the principal off, then you may be in a situation where you can’t refinance.
What can you do if you can’t refinance?
There are always options, the best and easiest one for many people is to contact their lender and simply ask for a better interest rate (unless you are on a fixed rate contract). There’s quite often a difference between the introductory interest rate and the rate existing customers are on. Working with a broker like Entourage can go a long way – contacting the bank on your behalf to negotiate a better rate is something we do for many of our clients who are happy with their bank but feel the rate has crept up.
Damien Roylance, Managing Director of Entourage Finance said, “We’re seeing some mortgage holders wanting to refinance to get a better variable rate, however it doesn’t always make sense for them to do it. From paying extra fees breaking a fixed rate mortgage through to, in a sense, being stuck because their borrowing power has gone down – these are just five of the reasons borrowers may need to stay put. I also see people making the false assumption that refinancing their loan term will save them money. Yes, they may see lower monthly repayments now, but the additional interest paid over the extended loan term is going to cost them much more.”