All of us get itchy feet from time to time, when things stay the same for too long – whether we want to change it up by travelling, getting a new job or having another baby, we all get the feeling that perhaps we could be doing things better, and getting more out of life. Therefore, considering you are locked into your home loan for upwards of 20 years, it is not surprising that at some stage you will get itchy feet for a change in your mortgage set up – but does that necessarily mean it’s a good time to refinance your loan?
As financial products are changing all the time, it is a good idea to regularly consider refinancing your loan to give yourself the chance to review new options and home loan deals. At the same time this doesn’t mean it is a good idea to regularly go through with a refinancing, and to help you make that decision, consider the following tips.
When to consider refinancing
Typically refinancing will cross your mind when interest rates drop, especially if your bank is one of the ones holding out on passing on those savings to its customers, or if you have locked your home loan into a fixed interest rate. However, refinancing when interest rates are low can bring with it its own issues, because when interest rates are dropping, that also means the economy is slowing, and you want to maintain as much stability in your finances as you can.
Therefore, before you consider refinancing because of interest rates, look at how much they have dropped, and what that means for your particular circumstances. There are all sorts of rules about how much rates should drop before you look at refinancing. Some experts say that you shouldn’t refinance unless you will save at least half a percent because the closing costs will eat into your savings, and even if you can avoid closing costs, you still shouldn’t refinance for less than a saving of a quarter of a percent.
However, a simpler way to decide is to look at how much money you’re going to save on your mortgage, based on what you still owe. For example, a 1% saving is a lot more worthwhile for someone with a $500,000 mortgage than someone with $100,000 remaining on their mortgage.
When considering whether to refinance you also need to look at how much longer you intend to keep the mortgage. For example, are you planning to move and sell your home or turn it into an investment in the near future? If you are you’re going to need a new loan at this time anyway, and you won’t have had a chance to recoup the losses from your refinancing costs in the short time before you refinance for a new loan again.
However, a good time to consider refinancing is when you can afford to structure your loan to pay it off sooner. In many cases people will refinance a 20 year mortgage into a 30 year mortgage to make their monthly repayments lower and more affordable. However, with the longer loan term there is more opportunity to accrue interest, so this will actually cost you more in the long term. On the other hand, if you can afford to refinance a 20 year mortgage into a new 15 year term then you can be saving thousands of dollars, especially if you can negotiate a lower interest rate at the same time.
The fact that everyone else seems to be refinancing their mortgages may make you think about refinancing yours too, but that doesn’t necessarily make it a good idea. Luckily the banks are looking at lending again and are loosening their lending criteria and offering incentives for those who refinance with them. Just make sure that the incentives being offered are worthwhile, and beneficial for your needs. For example, some banks will offer a discount off of your home loan amount while other will waive the fees for refinancing.
Types of refinancing to consider
There are also a number of ways to refinance your loan, depending on your motivations for refinancing and your financial situation based on the value of your home. For example, you can refinance your mortgage to make it more affordable, which is especially useful if your home has dropped in value. This will help to improve the long term affordability of your mortgage and reduce the risk of you losing your home to foreclosure.
Alternatively you may consider refinancing to take advantage of better loan features which can in turn save you money, or which simply better suit your changing needs. For example, you may refinance to a home loan which has a linked offset account as you are now able to keep a significant amount of savings in your offset account to reduce your loan interest. Or as you get older and closer to the end of your mortgage, you may refinance to a simple loan type to save money on features you no longer want or need.
Or, as we’ve already considered, you may refinance your home loan to take advantage of a lower inters rate. Just make sure in this case that you carefully consider the costs of this refinance, as breaking a fixed interest rate term can be particularly expensive, and often not worth the added expense for the minimal interest savings.
Why consider refinancing a mortgage?
You should consider refinancing your mortgage when you have something important to gain from the exercise. Look for both immediate and lasting benefits to refinancing such as:
- A better home loan. A better home loan will look different to different people, so use the tips above to work out what you need from your home loan, how much it will cost you to get it and what the benefits to your new loan product will be. You will be increasing your long term and your short term financial security and your home is less likely to be a risk in hard financial times.
- Increasing your net worth. Your net worth is the true indicator of your wealth, as it is calculated on what you own, less what you owe. For example a house valued at $250,000 with $50,000 remaining on the mortgage is more valuable to your net worth than a house valued at $500,000 with $480,000 remaining on the mortgage, even though the $500,000 house appears bigger and more opulent, the occupants actually have a lower overall wealth. Therefore, if you can refinance your home loan to reduce the interest you are paying and shorten your loan term for example, you have the opportunity to increase your net worth.
- Short term cash flow. Refinancing your home loan with the intention of reducing your monthly mortgage repayment can mean you have more money left over to reduce the day to day financial pressures on your household budget and reduce the risk of over extending and turning to credit, as well as giving you the financial breathing room you need to consider other investment options.
When you shouldn’t consider refinancing your mortgage
While there can be a lot of benefit to refinancing your mortgage there are also dangers involved which you need to look out for. Don’t refinance your mortgage if:
- There are significant costs. Both the home loan you are closing down and the new loan account you are opening can hit you with costs when refinancing. Therefore, make sure you compare and add up all of the costs before committing to refinancing, to make sure the savings you will be enjoying will make the refinance worthwhile.
- Seeking low interest rates at any cost. There is more to the cost of a mortgage than just the interest rate, so if you are lured into refinancing by the promise of a much lower interest rate, don’t just pay whatever fees you have to to get it.
- You can lose equity. That’s right, the valuable equity you’ve been slowly and steadily building up over the years as you repay your loan and your home increases in value is at risk when you refinance. This is because you are often changing the ratio between what you owe and what your property is worth so make sure if you are refinancing to access that equity that it is for a cause which will bring you greater wealth in another way.
- Reducing your net worth in the long term. If you refinance your loan to a longer term you need to be aware of the extra interest you will be paying over that longer loan term. While you may be refinancing to reduce your monthly repayments because your budget is stretched, it can be worthwhile to allow you to hold onto your house, but make sure you have a plan for getting your finances back on track, and your home loan costs back under control, and that you refinance to a mortgage that will be saving you money again, as soon as you can.
Remember, that you don’t always have to refinance with a new lender to save money. When you are considering refinancing talk to your existing lender first because they are actually very keen to keep you as a customer, and may offer you a discounted interest rate or added features on your current loan. This saves you the hassle of paperwork, and the costs of refinancing.
Over the last 3 years, Alban has been blogging about finance and personal loans. When he his not writing, Alban loves reading about investment strategies and shares.
Popularity: 1% [?]
