Refinancing 101: how refinancing works and what to look out for
Refinancing involves replacing your current home loan with a new one, typically to secure better terms, lower interest rates, or access equity. Essentially, the new loan pays off the existing loan, and you start fresh with the new terms.
Why refinance?
There are several reasons homeowners opt to refinance:
1. Lower interest rates
One of the primary motivations for refinancing is securing a lower interest rate, which can significantly reduce your monthly payments as you pay less interest on the loan, which can save you thousands over the life of the loan.
2. Change loan terms
- Shorter term: Refinancing to a shorter term (e.g., 25 years instead of 30 years), this will mean your repayments will be much higher but you won’t pay as much interest on the loan. This is not a common reason for refinancing, but it is an option.
- Longer term: Extending the loan term can lower monthly repayments, easing financial pressure, however, you will pay more in interest over the lifetime of the loan.
3. Accessing equity
Homeowners with significant equity can refinance to access funds for renovations, investments, or other major expenses.
4. Switching loan types
- Transition from a variable interest rate to a fixed rate for predictability.
- Move from a fixed rate to a variable rate if rates are expected to drop, or if you’d like access to an offset account.
5. Consolidate debt
Refinancing can combine multiple debts (e.g., credit card and personal loans) into one manageable monthly repayment, often at a lower interest rate.
How does refinancing work?
Step 1: Assess your current loan
Start by reviewing your current loan’s terms, including interest rates, fees, and remaining balance.
Step 2: Research, compare and apply
Shop around for lenders and compare options. Consider factors like interest rates, fees, and repayment terms. If you work with a mortgage broker, based on your discussions with them, they will research and compare lenders that best suit your needs, and apply for you - simplifying the refinancing process.
Step 3: Start repayments
Begin repayments under the new loan terms, ensuring you understand the repayment schedule and any conditions. If you are opening an offset account you will need to set this up with the bank and confirm which transaction account your payments will be deducted from - at Beck McLean Finance we will guide you through this or manage this on your behalf.
What to look out for when refinancing
Refinancing can be advantageous, but it’s essential to weigh the pros and cons carefully.
1. Resetting loan terms
Refinancing may restart your loan term (e.g., from 25 years back to 30 years), which can mean paying more interest over time. If possible, aim to align the new loan term with the remaining term of your existing loan to avoid this.
2. Less flexibility
Some refinanced loans may have stricter conditions or reduced flexibility, such as penalties for extra repayments or early loan closure.
3. Fees and costs
Watch out for hidden or upfront fees, including:
- Exit fees: Charged by your current lender for ending the loan early.
- Application fees: Costs associated with setting up the new loan.
- Fixed rate fees: If you are on a fixed rate, you may need to pay a break or exit fee.
How refinancing can affect you
Potential benefits
- Lower monthly payments: Free up cash flow for other expenses or savings.
- Total interest savings: Reduce the overall cost of your loan.
- Access to funds: Leverage home equity for major projects or investments.
Potential drawbacks
- Higher long-term costs: Restarting a loan term could mean paying more interest over time.
- LMI: If you have less than 20% equity in your property you will have to pay Lenders Mortgage Insurance (LMI).
Is refinancing right for you?
Refinancing can be a smart move, but it depends on your financial situation and goals. To determine if it’s the right choice:
- Calculate the total cost of refinancing, including fees and long-term savings.
- Assess how the new loan terms align with your goals.
- Consult a mortgage broker or financial advisor for personalised advice.
Refinancing is a powerful tool to optimise your finances, but it’s not one-size-fits-all. By understanding how it works, why it might benefit you, and what to watch out for, you can make an informed decision that sets you on the path to financial success. Need guidance on refinancing? Contact us today to explore your options and take control of your financial future.
