Think before you refinance the mortgage

2018-05-23
Continually refinancing the mortgage for the slightest of advantages can keep you going in circles rather than getting ahead Continually refinancing the mortgage for the slightest of advantages can keep you going in circles rather than getting ahead

Refinancing isn’t for everyone or every financial situation.

Refinancing a mortgage can put you in a better interest rate, but still increase your debt. Before you jump on the refinance-the-mortgage ride, here's six occasions when it might not be right for you

  1. The cost of the savings don’t add up
  2. You don’t plan on staying in the house longterm
  3. You're trying to pay off your loan sooner
  4. You're just switching to a fixed-rate mortgage
  5. You aren’t in the right position to refinance yet
  6. You're over 50

1. The cost of the savings don’t add up

The reason most people choose to refinance their mortgage is to get a lower interest rate.

  • Before you jump on the refinance merry-go-round, consider will you actually be better off in the long term?
  • Make sure the benefit you receive is worthy of the cost you'll incur.

If you’re already 5 years into paying down your loan and you later refinance back to a 30-year term loan, you can end up adding years back onto your loan.

Compare the cost of the refinance with the degree of the advantage it delivers

For example:

If the monthly repayment on a 30 year loan of $500,000 @6% was $2,500 and $2,396 @5.75% that represents a difference of $104 a month or $1,248 pa.

If the cost to refinance was $3,500 it might take you 2.8 years before you’ll regroup the additional costs spent on refinancing and extended the length of the overall loan.

Pro Tip: Don’t automatically believe that you’re better off with lower monthly payments if your loan has been extended an additional 5 to 7 years for no other reason.

2. You don’t plan on staying in the house longterm

If you plan on selling your home in the next few years, why not consider holding off on refinancing it. Selling too soon after refinancing could mean you won’t live in your home long enough to benefit from the savings benefits of lower rates and you’ll still have to pay the refinance costs.

Pro Tip: Most mortgages are now portable and can be taken with you to your next security property rather than forcing a refinance. Changing the existing security property to the new property purchase but keeping the same lone might be a cost-effective option worth discussing.

3. You're trying to pay off your loan sooner

Going into more debt to pay off debt is an unusual strategy.

There are many ways to pay off your mortgage faster but they all start with

  • using an offset account to reduce the daily interest calculation on your mortgage repayment, and
  • simply finding ways to increase your repayments.

Whether you consider rounding up repayments to the nearest $100 and learning to live to that level or increase your emergency fund held in an offset account, it won’t take long until you simply adjust to your new cost of living accordingly.

Pro Tip: If you don’t have a 100% offset account, don’t let a bank simply take the minimum repayment they want. Taken control.  Where possible never just make minimum repayments; specify an agreed payment amount you want to push into your mortgage each month, fortnight or week.

4. You're just switching to a fixed-rate mortgage

Fixed rate homes loans can be useful for different times in your life but rely on you making a prediction the mortgage interest rates will rise more than your fixed rate. Paying a variable rate is often more cost-effective in the long term.

  • Perhaps you’re studying part-time to improve your employability and need the certainty of a fixed repayment amount for a period of time.
  • Perhaps you have an investment property and you just want to budget sufficient to service that tax-deductible debt while you focus on paying down your non-tax-deductible debt on your family home.
  • Perhaps you want to reduce the possible future increases in your interest rates and have split your home loan into 50% fixed interest rate and 50% variable interest rate with an offset account offsetting the higher interest rate.

So if you’re just wanting to fix your interest rate, remember the fixed rate will revert back to a variable rate so make the most of the time and opportunity they can provide.

5. You aren’t in the right position to refinance yet

When it comes to refinancing, timing is everything.

  • Perhaps your credit history took a hit over a disputed bill or an error
  • Have you’ve recently switched jobs and in a probation period
  • Do you have wages with 30% or more relying upon recurring commission payments?

The timing of these events may interfere with your borrowing options.

Changes in real estate values

If for some reason your home has decreased in value, (common in units) refinancing your home at the wrong time can tack on extra costs, like lenders mortgage insurance (LMI). Borrowers with small deposits — or refinancing with low levels of equity in their home — have to pay LMI until their equity reaches 20% of the home’s value. If the property valuation is low the funder will seek to renegotiate the terms of the mortgage and you may end up inadvertently paying more for your money.

Pro Tip: Beware of Equity Stripping
Uncontrolled credit card spending can soak up the majority of a person's income and many people use the refinance as a way to pay out high credit card debts and reduce their overall debt repayment obligations.

Consolidating consumer debt into a lower rate mortgage can be useful, but if you don’t change the circumstances that got you into the credit card debt levels, repeating the refinance cycle only strips equity from your home.

For example:

People who refinance a home to pay out $100,000 of credit card debt, strip the equity from their home by that same amount and may even face having to pay an LMI premium to enable them just to consolidate debts through the refinance.

6. You're Over 50

As everyone is living longer, the possibility of increased numbers of Australians carrying mortgage debt in retirement is a very difficult issue. Older Australians refinancing now face shorter-term mortgages of 15 to 20 years (not the traditional 30 years) and this increases the repayment levels at a time when borrowers need to be preparing for retirement.

  • Maintaining an existing mortgage, making additional repayments and using an offset account, may be a better option than renegotiating to a lower interest rate but compressing the mortgage term into 15 or 20 years.

If you do need to consider a refinance and you're over 50, there are additional requirements you’ll have to meet. A Financial Adviser is the best person to represent you to a funder in this scenario.

Additional borrowing requirements for the over 50’s

For those over 50 years who need to refinance, you’ll have to provide an exit strategy to show how you will plan to meet your mortgage debts in retirement with the anticipated reduce income levels.

  • need to demonstrate a very good reason
  • a material benefit to you (not just to help the kids with a home deposit)
  • both a plan and an ability to either pay out the mortgage before retirement
  • a plan to do that in retirement.

This will require a thorough assessment of any superannuation funds, saleable assets including investments and property and consideration of the type of work you may be trained to do.

For example:

A Lawyer or a Doctor is more likely to be able to continue to work into their 70’s where a bricklayer is not.

The problem of retiring with a mortgage debt

Research by REST Super indicates 46% of Australians expect to retire with some form of debt;

  • 21% with retire with a mortgage
  • 25% with retire with credit card debt

Currently, 10% of retirees are still paying off a mortgage debt with 15% of Australians aged 60-64 still owing more than $100,000 on their mortgage.

Shrinking home ownership

As fewer Australians own their homes outright, it’s likely the numbers of people taking debt into retirement will increase.

  • With home ownership slipping out of reach for many Australians, those who don’t buy by their late 40s are likely to never afford a home.
  • Those that do will be forced to take debt into their retirement but might only qualify for a 20-year mortgage (not the traditional 30 years for a younger borrower) with significantly increased repayment levels over that shorter time.

Refinancing can be a good choice if you can lower your repayments and still save more than it cost you to achieve. However, a refinance is not for everyone, so be sure to know your numbers first.

Contact us today and see if refinancing the mortgage is not right for you.
Drew Browne

Drew specialises in helping people protect and provide for what matters most in their lives. He's an award-winning writer, speaker, financial adviser and business strategy mentor.  His company Sapience Financial and Investment Services is a Certified B Corp committed to using business solutions for good in the community and a member of the international B1G1 Business for Good Giving Community.  Drew writes for successful Small Business Owners and Entrepreneurs at Smallville, his blogs can be read on Amazon.com and in 2017 Drew was recognised in the Australian Westpac Businesses of Tomorrow national awards.

drew browne pic

Drew Browne

Sapience Founder & Director.
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