Smart refinancing strategies

A home loan isn’t just a debt, it can also be a financial tool that can be used to build wealth and when managed properly to facilitate your lifestyle – and smart refinancing strategies can assist in getting this in place .

Refinancing means replacing your existing loan. Be it a home or investment loan with one that is more competitive and/or that better suits your current needs, so that you wind up with a lower overall cost and a loan that has the right structure and features for you.

People refinance for several reasons

• To consolidate their debts into the one facility.
• To benefit from a lower interest rate.
• To access equity for a deposit on an investment property or a motor vehicle, renovations or other purposes.
• To review their current rate, product features and fees relative to the rest of the market and to ensure the facility they have in place is competitive and has the appropriate features for their stage of life.
• To move from a low doc to full doc facility.

Let’s look a closer look at some of these refinancing strategies and what to consider;

Refinancing strategy – Debt consolidation

Your home loan interest rate is probably the lowest form of interest you will need to pay on any loan in Australia. Credit card interest rates can be as much as four times higher than your home loan interest rate and car loans and personal loans will have higher rates and can also prove to be a drain on your finances.

As such borrowers commonly refinance and consolidate all of these debts into their home loan. This gives them access to a  cheaper rate and sometimes to some equity to pay down some of these personal debts.

While consolidation of personal debts into your home loan can reduce the amount of interest payable on a borrower’s overall debts considerations are;

• Aim to keep your payments at the same level to take full advantage of the lower interest rate and pay off your home loan sooner.
• If you are saving you can reduce the repayments and use the money to make other investments – however ensure these funds are being used in an effective manner.
• Structure your facility in a way that separates the consolidated debt from your original home loan. This means the consolidated debts maintain their own statements and repayments and you still repay these within the timeframe the funds were borrowed for. For example if a motor vehicle depreciates over 5 years aim to have this portion of the debt cleared within that timeframe. This will ensure these debts are properly managed while having the benefit of the same interest rate as your mortgage.

Refinancing strategy – Switching to a lower interest rate and saving money on home loan repayments

Interest rates change frequently. With lenders making adjustments in response to economic influences, RBA rate movements and policy directives from industry bodies such as the Australian Prudential Regulation Authority (APRA). Additionally, smaller lenders and new lenders in the market place often offer lower interest rates than the big banks.

Research has found that borrowers who held the same home loan for more than ten years could potentially have paid thousands more in interest than borrowers who monitored their interest rate and switched mortgage products every two to three years.  For example, if you have a $500,000 mortgage and can manage to reduce the interest by one percent, over 30 years you could save $100,000 in interest repayments.

As such one of the major reasons people refinance their home loan is to secure a better interest rate. Reducing your repayment amount and saving a considerable amount of money over time.

Additionally, refinancing to a lower rate is not only an opportunity to reap cost savings. It also offers a way to build equity and take advantage of getting a facility with more appropriate or flexible terms and features hat may not have been available when you originally took out your loan. These may be more reflective of your current stage of life and objectives.

Refinancing strategy – Releasing equity

Borrowers tap into the equity in their home for a whole host of reasons. Commonly to use the funds as a deposit on an investment property, renovate their home or upgrade the family car, assist with a children’s education fund or to invest in a business or stocks and shares.

When accessing the equity in your home there are many variables to take into account. These include the property’s value (to have equity to access in the first place, your property needs to be worth more than your loan), your current Loan to Value ratio (LVR), the lender’s credit policy and the type of loan structures available.

The equity in your home is calculated by subtracting the amount you owe from the current value of your home. For example, if you have a loan of $400,000 secured against a home that is valued at $800,000, you have an equity position of $400,000.  Through refinancing and having a purpose for accessing the equity you can secure additional funds. Let’s say we take the LVR back to 80% – then they could borrow an additional $240,000 to take the total borrowings to $640,000 against the value of your home of $800,000.

Let’s take a closer look at 2 of the common reasons people access their equity.

Accessing equity for investing in property

Property investment is one of the most popular ways of building wealth for your future. However it is often seen as out of reach to a lot of Australians. A key challenge being to raise a deposit. However, refinancing may enable you to unlock equity to use as a deposit on an investment property.

Accessing your equity will increase the amount you owe on your original property and your mortgage payments. Additionally you will have the associated repayments from a mortgage on the investment property and the costs to run this. With good planning and the right property you can potentially service these through rental payments.

Key to this strategy is planning, obtaining the right finance and doing your property research. This will help to support your capital growth and yield objectives and give you a platform to build your wealth over the long run.

More information on accessing the equity in your home for property investment can be found at this blog.

Accessing equity to renovate or extend your home

Renovating or extending your current home to meet the needs of your growing family or a changing lifestyle is often a better option for some than purchasing an entirely new home. By accessing your equity to renovate or extend your home, you will be able to create the home that exactly meets your needs and if you’re careful about the improvements you make, perhaps even increase its value at the same time to offset this cost over time.

Refinancing strategy – Review of your facility relative to the rest of the market

We have an ever-evolving and competitive market place. Mortgage products become superceded and outdated and our circumstances change. As such it can be beneficial to get an understanding of what products and features are available now compared to when you established your mortgage. You can potentially take advantage of features that may not have been relevant to you or available a few years back. For example, the ability to make additional or more frequent repayments, the ability to redraw these funds if you need to, the ability to link offset accounts to the loan to manage cashflow and budgeting and to maximise your savings and save on interest, and the ability to transfer the loan if you were to move to a new house are just some examples of features available.

Some products offer features that could save you money outside of your mortgage. For example, fee free transaction accounts or low-rate credit cards. Other mortgage products may offer rewards, incentives or even more flexibility.

Refinancing strategy – Going from low-doc to full-doc

Lenders presently consider low documentation (low-doc) borrowers to be riskier propositions than full documentation (full-doc) borrowers. As such high-risk loans often have higher interest rates attached. As such low-doc borrowers should evaluate their mortgage and their financial situation on an ongoing basis.

If you can prove stability in your job and your finances with a solid paper trail, you may be able to switch to a full-doc loan, where there may be a lower interest rate or other benefits such as lower ongoing fees or more flexibility.

The borrower would be required to provide current financial statements. This would include individual tax returns for the last two years and any company, partnership and trust returns where income is derived via these means. Profit and loss statements may also be requested

Important considerations when refinancing are

• The value of your property. This will determine the equity that can be realised.
• What, if any fees and costs are associated if you were to change lender and to take the new loan.
• Understanding the potential savings. This can be done by simply calculating the savings from the difference in rates and deducting the costs associated in switching products to see the benefits.
• Other benefits that may not actually be savings, but things such as access to new loan features or further cash equity.
• Your equity situation.  If you currently have a high borrowing ratio – that is, the amount of your loan equates to more than 80% of the value of your property assets – then there’s a chance that you may be in or near a negative equity situation. Negative equity is where you owe more than the property is worth. This would become an issue if you were considering a refinance, which will formalise that loss. You would steer clear of refinancing if that were the case.

Anthony Landahl | Equilibria Finance

Note: This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.