Refinancing Case Study - Bob and Joan Brown want to switch to a better home loan deal
It’s coming up to seven years since Bob and Joan took out their first home loan. Their financial planner has advised them that now is a good time to review their current no frills home loan and find a more competitive deal in the market. One that is suitable to their current financial situation.
Switching and refinancing to a home loan with a lower interest rate will save the Browns money and mean they will pay off the mortgage sooner. The other pro of refinancing the home loan is having additional money to renovate. Now with two children, the Browns are desperate to expand the family home and build a decent playroom and a parents retreat up top!
Determining their equity
Before choosing to refinance their existing home loan the Browns need to work out how much equity they have built up. Home equity is the difference between the market value of the property and how much you have left owing on the mortgage.
The Brown’s home is valued at $850,000 and they have $550,000 outstanding on the loan so the equity built up in their home is $300,000. The Browns are in an ideal situation to refinance as they have more than the equity minimum of 20% in their home.
If they were to refinance their home loan without at least 20% equity they would likely have to pay lenders mortgage insurance (LMI). This insures the bank against the borrower not being able to make the mortgage repayments
Putting their current home loan under the microscope
The mortgage the Browns have on their first home loan is outdated! There’s a high annual fee and they’re not happy with the services provided by their lender. They have a fixed interest rate of 7.5% on a loan of $700,000 due to end shortly with monthly repayments of $5,173. There’s also little flexibility when it comes to making additional repayments and offsetting the loan. This has worked against the Browns as Bob has received a substantial bonus the last two years which could have gone straight into the loan.
Picking a new home loan
Joan starts by doing homework into the types of home loans, looking into the pros and cons of each. Clearly a fixed rate loan is no longer working for the Browns. When they first took out the home loan seven years ago, they wanted the monthly repayments to remain the same for budgeting purposes, so a fixed rate suited their situation at the time. On a seven year fixed term, now is definitely the right time for the Browns to refinance the loan as the revert rate of a fixed rate loan is likely going to be less competitive than a lender’s best.
Using a switch and save calculator Joan plugs in some figures including their home loan amount, current monthly repayments and property value. To Joan’s delight, she comes across a variable rate home loan of 4.5%, making the monthly repayments $3,891. That’s a saving of $1,282 a month and over 25 years that’s a whopping saving of $384,633! Not to get too excited, Joan is aware variable interest rates do fluctuate in accordance with market rates. However, she is confident she’s going to save thousands of dollars by refinancing the home loan with a variable interest rate.
Choosing the refinancing loan features
Having lucked out when it comes to features with their first home loan, the Browns are eager for some additional benefits when they refinance the loan. They investigate the home loan features that are offered with a variable interest rate and are adamant on having fee free extra repayments. Bob is on track to earn regular bonuses from his employer while Joan is making cash from selling her artwork. By putting these bonus earnings towards extra mortgage repayments, the Browns will pay less in interest while bringing down the principal.
With home renovations on the horizon the Browns are cautious additional costs may arise during the building process which are out of their control. So they’re going with a home loan that features a redraw facility, which goes hand in hand with extra repayments. Bob and Joan will be able to dip into the extra repayments they’ve made if they’re struck with any unforeseen bill or repair during renovations. Of course the Browns can use the redraw facility for other unexpected expenses such as a medical emergency, or school related fees.
Considering the switching fees
Like most banking products, refinancing a home loan has its fair share of fees and charges! The Browns need to be mindful of factoring in these fees when making the switch, to ensure it’s worth the change.
The first step Joan makes is to see how much her current lender is going to charge them for an exit fee and any other penalties for terminating the loan. The Browns will be charged a termination fee of $350 but will avoid a break cost fee as the fixed rate term period of their home loan is soon to end. Their new provider is going to waive an application fee as they’re creditworthy borrowers. An application fee can be as much as $1,000 so the Browns are happy to dodge that charge. They will however pay a registration fee for rolling the mortgage over to a new provider.
Finally, the new lender will need to value the Browns property which could set them back around $200, the cost for sending out a valuer to their home. While there are these additional fees to refinance their loan the Browns are confident it will be well worth it in the long run!