Seven traps to avoid when refinancing
Last week’s cut to the cash rate will start many borrowers thinking about refinancing their home loan. But like any financial decision, switching mortgages should not be taken lightly.
Here are several traps to avoid:
- FAILING TO CONSIDER YOUR OWN CIRCUMSTANCES – if your situation has changed since you first took out your mortgage, it’s wise to reassess whether you’ve got the right product. However, some changes of circumstances may mean that the loan you’re in will be the best deal you can get.
If you have become self-employed since first taking out your mortgage, for example, you may be required to take out a low-doc loan if you refinance. These tend to charge higher interest rates than standard discounted home loans, so it’s likely you’d have to pay more.
Similarly, if you or your partner has retired or stopped working for some other reason, your ability to repay a loan may be assessed differently by a new lender than under your existing mortgage contract.
- IGNORING SWITCHING COSTS – Fixed rate mortgages charge break fees for exiting early. These may make it prohibitively expensive to switch.
Exit fees for variable rate mortgages were banned in 2011 and those on most on older mortgages would have expired by now but there are still costs associated with taking out a new mortgage that should be balanced against any savings you’ll receive by getting a lower rate.
Fees to watch for include discharge fees paid to your current lender for preparing documents to finalise and pay out the existing loan; application fees to the new lender; valuation fees charged by the new institution for obtaining an up-to-date valuation on the property; and land registration fees for replacing the mortgage with the existing lender with one from the new institution.
Canstar estimates these refinancing fees can add up to around $1,000. Consider whether that cost outweighs the benefits of a lower interest rate over a reasonable pay-back period.
- COMPARING APPLES WITH ORANGES – if you have a fully featured mortgage, make sure you’re comparing the cost of a similar loan. Basic mortgages typically cost less than fully featured options, but a loan with more features may save you money in the long run if you take advantage of it.
Holding $10,000 in an offset account could save $250 a year on a $250,000 loan that charges 5% interest. That may not sound like much, but that’s the equivalent of 0.2% lower annual interest rate.
On the other hand, if you’ve never used the features such as offset accounts, discounted credit cards or home insurance policies that come with some loans, this might be a good time to dispense with the extras.
- GOING FOR A FIXED RATE – rates are at historic lows. Fixed rate mortgages are available at 4.35%, fixed for two years on a 30 years mortgage (from Loans.com.au), according to Finder.com.au. Variable rate loans are offering 4.25% (also from Loans.com.au).
If you want to be sure of what your repayments will be, consider a fixed rate loan but remember you will be trading off flexibility.
Most fixed rate loans prevent you from making extra repayments or repaying in full before the end of the term. Should you circumstances change, you may be hit with break fees if you choose to lock in the interest rate.
- FAILING TO APPROACH YOUR EXISTING LENDER – rather than rushing out and swapping lender, have you approached your existing lender to see if they can give you a better deal?
If there are lower rates in the market and you’re a good customer, they may go out of their way to keep you. It can be more efficient and less costly to get a better deal where you are rather than moving externally, especially if you hold other financial products – bank accounts and credit cards for instance – with the same institution.
- IGNORING SOME OF THE OPTIONS – whether you’re using a mortgage broker to help you refinance, referring to a comparator website or succumbing to advertisements, remember that there are other options out there.
Brokers include only a sub-set of available lenders on their panel of suggestions. You may get a good deal, but is it the best in the market? The only way to find out is to research more widely.
Again, there’s an element of trade-off here. You might find that near enough is preferable to spending hours of investigation to get the best of the best.
- FAILING TO CONSIDER THE LENDER’S HISTORY – if you’re switching to a variable rate, remember these can change at any time. Some lenders offer attractive promotional rates to lure borrowers in but fail to pass on subsequent interest rate cuts in a timely manner.
Many lenders have quickly followed the Reserve Bank of Australia at this rate cut but that’s not what happens every time. A month-long delay in passing through a 0.25% interest rate cut would cost $83 in interest repayments on a $400,000 mortgage.
Lenders may even lift rates out of cycle with the RBA if they decide that’s right for their business.
It’s very difficult to tell which lenders will be the ones to do these things but investigating their behaviour when interest rates changed in the past may sound some warning bells.
This article was first published in Property Observer