Deal time: David Thornton on refinancing your mortgage

Interest rates are super-low and lenders are keen to do business, so make sure your mortgage still suits your goals

For some homeowners, mortgages are a set-and-forget proposition. They get what they think is a good rate, before then turning their attention to other priorities. This is not a good strategy at anytime, much less the time we’re in now.

Rates and lending conditions change significantly many times during the life of a 30-year loan. And now is as good a time as any to get the best deal.

“It’s important for people to refinance because the rates have come down so significantly, and we’re seeing a lot of customers on old rates,” says David Hyman, the chief executive of Lendi, a home loan platform.

For those looking to refinance, the pandemic has been a blessing in disguise, with central banks taking a sledgehammer to rates in an attempt to stimulate their economies.

Further still, the Reserve Bank has signalled that it expects rates to stay this low for the next four years.

“The board will not increase the cash rate until actual inflation is sustainably within the 2%-3% target range,” RBA governor Philip Lowe said in his policy decision statement. “The board does not expect these conditions to be met until 2024 at the earliest.”

Hyman says that in 2020, at the peak of Covid, not only did we see a number of rate cuts, but there was a lot of government support around the whole self-funding market.

Banks have passed along most of the cuts. “We’re now seeing a number of the big banks with 1.99% fixed rates for four years. If we

rewind a year, rates were 1%-2% higher across the board, so it’s the best time in history for someone to look at refinancing if they haven’t already,” he says.

“The only neobank lending in the market, 86 400, is competitive on the variable rate, but because they’re a new player they don’t have any fixed-rate offers.”

Competition heats up

The majors are very competitive at the moment due both to the rate cuts and favourable lending facilities.

“The RBA subsidised some of the wholesale lending market through its term funding facility (TFS), which it introduced at the height of Covid as one of the fiscal stimulus measures that underpinned lending in the economy,” says Hyman. “Effectively, it’s a 0.25% lending facility.”

The savings can be huge. Over 2020, Lendi’s refinancing customers reduced their interest rate by 1.05% to settle on a new median interest rate of 2.54%.

“For a customer with a $400,000 mortgage, refinancing to an interest rate of 2.54% represents a saving of $219 per month or $2628 over 12 months [for a 25-year loan, paying principle and interest],” says Hyman.

But refinancing is about more than just the rate. “There are a range of reasons why customers may want to refinance their home loan,” says Alan Hemmings, chief executive of homeloanexperts.com.au.

The traditional way of looking at refinancing is to get the cheapest interest rate. Today, the best approach is to understand what your goals are over the short, medium, and long term, and whether the refinancing meet these goals.

“It can be as simple as wanting a better interest rate or, as we are seeing at the moment, a cashback offer,” says Hemmings. “It may be that they are wanting to draw some equity but the existing lender is not willing to lend the additional funds, or the customer may have had to go with a non-mainstream lender for their loan and is now in a better financial position to move to a mainstream lender.

“The length of the loan term is also a key variable that will influence how much you pay in the long run. If a consumer refinances to a cheaper interest rate but reverts back to a 30-year loan term, they may end up paying more than if they stayed in the higher interest rate.”

Getting started

Hemmings says any time is a good time to look at refinancing. “Consumers should be reviewing their loan annually and deciding whether the existing loan continues to suit their needs.”

Like any process worth doing, it takes some homework. “Any new lender is going to want to see if the consumer can afford the loan, so will verify all income and living expenses. They will also want to see the repayment history of the loan being refinanced to make sure the consumer is repaying the loan on time.

“As it stands at the moment, it is no faster doing a new home loan application than it is a refinance, and come loan settlement it can actually be slower as the lender

On a $400k mortgage, refinancing from a 3.55% interest rate down to 2.54% saves $219 a month, or $2628 a year

losing the consumer can wait up to 20 days before processing the settlement.”

A good first step is to hop onto a comparison website such as Lendi, Compare the Market, or RateCity.

A mortgage broker could be the next port of call.

“As of January 1, the ‘best-interest duty’ applies to mortgage brokers, so consumers can be assured they’ll have someone acting in their best interests, whereas banks don’t have that obligation,” says Hyman.

Brokers will help match your short-, medium- and long-term goals with the loans on offer. They’ll help ensure you’re getting a great rate and low fees, while also matching other features to your needs.

“They should then stay in touch with the client to make sure the loan continues to suits their needs,” says Hemmings.

Fixed versus variable

Borrowers then need to decide whether to go with a fixed or variable rate. There are pros and cons with each.

Variable rates provide the borrower with far greater flexibility over a fixed rate. In the end, you may be able to pay off your loan faster because refinancing is easier and doesn’t incur the break fees usually incurred when refinancing from a fixed-rate contract.

In addition, the holder of a variable-rate contract stands to benefit if the bank’s funding costs drop. Funding costs are made up of more than simply the cash rate. It’s also dictated by things such as the rate at which banks lend to each other, the credit spread demanded by institutional investors and deposit pricing.

By the same token, variable rates can increase for the inverse reasons.

“It’s a complex mix of variables and a change in any of these components may cause banks to adjust their lending rates in either direction,” says Drew Hall, head of Macquarie Bank’s head of banking products.

A strong case can be made for fixing your rate. The Reserve Bank has signalled that rates are unlikely to drop further, providing guidance only as to the conditions that would need to be in place for them to go up.

“Given where we sit in the interest rate cycle, and if you don’t think the cash rate will go into negative territory, currently fixed rates are well ahead of variable rates. So, we’re seeing fixed rates well below 2% while variable rates are in the mid 2%,” says IOOF lending specialist James Thompson.

“If you sit in the category of a borrower who’s in an owner-occupied property, not looking to sell in the next few years, then a fixed rate is something to look at closely.” On the other hand, by fixing the rate you give up some flexibility. According to the Australian Securities and InvestmentsCommission’s MoneySmart website, the break fee may be high. “Generally, the more interest rates have come down since you took on the fixed rate loan, the higher the break fee will be.” Fixed-rate loans also have fewer features. It’s unlikely you’ll be able to redraw funds or link to an offset account. Choosing between fixed and variable isn’t a totally binary decision. You can have a bit of both worlds by splitting the loan.

“You take advantage of two different types of facilities, playing both sides, where you get the fluctuation of the variable rate but the fixed component adds some stability to your cash flow,” says Thompson.

Equity plays a key role

The loan-to-value ratio compares the size of the loan to the amount of equity in the property. At times when the market value of the property may have dropped, this becomes important in any refinancing offers.

“Like any new home loan, it is best to have at least 20% equity to avoid paying lenders mortgage insurance,” says Hemmings. “However, even a loan that has an LVR above 80% can be refinanced, but new lenders mortgage insurance will be payable thereby increasing the cost of the new loan.”

Establishing equity is not consistent across the industry; lenders assess it differently.

“Although you may have more than 20% equity with one lender, when you apply to the new lender the valuation on your property may come in a little lower and move you over the 80% LVR hurdle and lenders mortgage insurance will become payable,” says Hemmings.

Some banks may ask you to inject capital to reduce the LVR. Again, whether you go down this road will depend on weighing up whether this is the best allocation of funds for your circumstance.

“The conversation may be, ‘If we do inject that capital into the loan, we may lose that liquidity until you reapply for a facility to take the cash back out,’ ” adds Thompson. “Maybe you want to use that capital to buy a car or make some other investment.”

At the end of the day, it’s about matching your goals and needs to the products offered by the market. Both will change as we move through life, so your mortgage should too.