Smart Investor: Getting Started, September 2012

Smart Investor, September 2012

So you see an ad from a bank for a new mortgage rate, lower than the one you’re paying right now. Your first thought is: well, I should refinance. But should you? There are plenty of considerations before taking that path.

Firstly, it’s true that rates vary in Australia, which is a competitive market for lenders and brokers. So it’s entirely likely that if you compare your mortgage with everything else that’s available, you will find something that looks better. One good way to start searching is to use an independent aggregator website like Infochoice, which compares not only the rates on mortgages but the various terms and conditions of the policy – a very important consideration.

Additionally, Australia is home to dozens of mortgage brokers whose job it is to understand and compare the many mortgage products out there, and to assess which one is best for an individual client. And there is an awful lot of choice to sift through: one broker says it has access to over 800 mortgage products from 30 lenders, for example.

One thing brokers are looking for – and you should be looking for – is known as the true comparative rate. That’s because, although it’s very easy to just compare headline interest rates, that doesn’t give you the whole picture, because there will be other fees and charges attached to your loan. Just because a loan has a lower headline rate than the one you had, it doesn’t automatically mean your repayments will be lower.

Another consideration is the terms of your existing loan. Is there an early resettlement charge, a penalty clause or a discharge fee? How much is it? This may tip the balance between refinancing making sense and not.

Then there’s your own circumstances. You might not want to change lenders just because the rate is better elsewhere. Perhaps there is a change in your own financial situation. Perhaps you want to borrow more money than before, to pay for renovations, or even to invest in another property. Maybe your credit card debts are getting out of hand and you want to consolidate your debt – everyone knows a mortgage interest rate is lower than a credit card rate.

Or perhaps you want to switch from a variable mortgage to a fixed rate one in order to lock in historically low rates – a common approach now, although some economists think rates have further to fall before they reach the bottom.

Before making the plunge, though, consider the other side of the coin. We’ve mentioned prepayment penalties on your existing loan, but here are some other considerations. If you’re not going to own the property for much longer, than it may not be worth the hassle of refinancing, particularly if your new product also has a prepayment fee. Secondly, although the headline rates on the new product look good, is your credit history strong enough to get them? If you’ve been bruised by the financial crisis you might find a new lender less willing to be generous than your existing one.

Above all, remember that applying for a mortgage is always somewhat painful. There is always a need for documentation you don’t have to hand. In this era, banks have more questions than ever before about your finances: how you got them, how consistent they are, what your liabilities are. If you’re self-employed or a freelance, for example, persuading a bank to lend to you is an exercise in banging your head against a wall. And remember that your new loan will include a host of fees, not all of them immediately apparent. There may be entry, exit, application and valuation fees, and there will certainly be stamp duty, and probably legal fees.

Consider, too, some alternatives. If it’s just a question of needing more money, does your existing mortgage provider have a redraw facility? It’s always worth telling your existing lender that you’re thinking of refinancing, because you’d be surprised what response you might get – if you’ve been a good customer and made all your repayments on time, they’re likely to want to keep you around, and may waive fees or make some other offer to stop you from straying. And if you are borrowing more money, have you stress tested yourself – worked out how you would be affected if you lost your job, or if a tenant moved out?

So, how to do it? When you’ve identified the product you want, put in your application and jump through the many, many hoops involved in getting the loan approved. Once that’s done, you need to tell your existing lender that you are refinancing – if you’re using a mortgage broker they may have done this for you – and then one slightly tricky part of the process is getting the two lenders to talk to one another. The changeover will need to take place on a specific day, and you may find your existing lender needs a certain period of time to do the admin – 10 days is not unusual  – which can be an issue if the refinancing is partly to finance a new home purchase. Be prepared well in advance and don’t be surprised if your existing lender drags their feet a bit.