How does refinancing work?
Refinancing is a popular option for homeowners who want to reduce their mortgage repayments, access home equity, and save money on their home loans.
While there are lots of different types of refinancing you can do, the most common kind is a rate-and-term refinance. This guide covers the ins and outs of refinancing and answers your questions about how it all works.
How refinancing works
When you refinance, what happens is essentially a transfer of the ownership of your home loan debt from one lender to another.
For example, if you have a home loan with Bank A but would rather have one with Bank B because it offers a better interest rate or features, you’ll need to refinance your home loan.
In this scenario, Bank B will pay Bank A the remaining balance of your loan, and you will now have to make repayments to Bank B. This means Bank A will consider your original loan paid off, ending your commercial relationship with them.
Refinancing costs to be aware of
But before Bank A closes your old home loan completely, you may have to pay a discharge fee which, depending on the lender, can cost anywhere from $0 to about $800, according to the Mozo database.
If you’re thinking about going down this route, it’s important to consider the cost of refinancing. As most borrowers do it to save money, having the costs outweigh your savings would be a waste.
How much could I save by refinancing my home loan?
Use a refinance calculator to estimate how much you could save by switching. Below is a hypothetical example of how much refinancing could save, giving you an idea of why a competitive interest rate is so important.
Refinancing example
Sally and George bought their dream home a few years ago with an $800,000 mortgage at a 7% interest rate. They initially took out a 25-year loan, but after 5 years, they noticed interest rates had dropped and decided to refinance to a 6% interest rate for the remaining 20 years of their home loan.
Here’s how much they saved by refinancing:
Original loan at 7% p.a.
- Loan amount: $800,000
- Loan term: 25 years
- Monthly repayment: $5,654
- Total interest over 25 years: $896,270
- Total repayment over 25 years: $1,696,270.
Refinanced loan at 6% p.a.
- Loan amount: $729,297
- Remaining term after 5 years: 20 years
- Monthly repayment: $5,225
- Total interest over 20 years: $793,233
- Total repayment over 20 years: $1,593,233.
Difference after refinancing
- Monthly repayment difference: $429
- Total interest paid difference: $103,037
- Total repayment difference: $103,037.
By refinancing from a 7% to a 6% interest rate, they managed to save $429 each month and $103,037 interest over 25 years.
When should I refinance?
As a general rule of thumb, if you don’t stand to save money by refinancing, then it might not be the right time to do it.
The costs of refinancing can add up quite quickly and negate the potential savings you make from switching to a lower rate.
While you might be able to refinance to a rate that’s slightly lower than your current one, you need to consider the cost of paying discharge, application, and valuation fees, and lenders mortgage insurance (LMI) if you don’t have a loan-to-value ratio (LVR) below 80%.
However, if property prices in your area have risen significantly since you first got your home loan, then the value of your home might have gone up too, giving you a better bargaining chip to access even lower rates thanks to home equity.
So, it’s worth doing some maths or seeking professional financial advice, to help work out if it’s the right time to refinance for you.
Can I refinance to a fixed-rate loan?
Refinancing from a variable to a fixed rate home loan is a common way to insulate yourself from rising interest rates like we saw from May 2022 to November 2023.
Aside from softening the impact of rate rises, refinancing to a fixed rate can offer you the comfort of consistent mortgage repayments that are locked in for up to five years.
However, you run the risk of missing out on rate reductions when interest rates finally come down.
The process for refinancing to a fixed rate is the same as you did to get a home loan in the first place.
How to refinance a home loan in Australia
- Assess your current loan and ask yourself what you’d like to change. Do you want a lower interest rate? Do you want to have access to different features or more favourable conditions?
- Shop around for a new home loan and find one that matches your new requirements. A home loan comparison can give you plenty of information about a product and its features to help you find a good fit.
- Complete an application form for your new home loan, just like you did for your first loan, and submit it for approval.
- After your refinance is approved, sign the relevant paperwork and your new lender will use your new home loan to pay off your old mortgage. Then, you can start making repayments for your new loan.
If you have never checked your rate against competitors’ rates, then it’s definitely worth exploring your refinance options.
Mozo’s Home Loan Report 2024 found those who compared their rate every 6 months had a rate 0.38% lower on average than the 1 in 5 Aussies who have never compared since getting their home loan. On a $500,000 loan, that equates to monthly savings of about $118.
So, if you’re feeling like it’s time to save money, compare refinance loans and see if you can switch and save.
FAQs
Is there a bad time to refinance?
While everyone’s situation is different, a bad time to refinance could be when interest rates are trending heavily upwards, or heavily downwards.
Imagine, for example, that you’ve decided to refinance and have found a home loan with a lower interest rate than your current one. You decide to apply for it and pay all the fees associated with refinancing then, a week later, the RBA cuts interest rates.
Other home loan rates start to drop significantly lower than the loan you’ve just been approved for, and you’re left with the choice of refinancing again (and covering the costs for a second time) or sticking with your new home loan.
That being said, if rates start to come down and your new lender drops theirs too, you may be able to negotiate with them to get a rate reduction. But it’s not a guarantee.
Are there downsides to refinancing?
The main downside is that it costs money to refinance. So, you have to make sure you’re not paying more to refinance than you could save by making the switch.
Also, if you refinance while you still have an LVR of over 80%, you may have to pay LMI to your new lender.
* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.
** Initial monthly repayment figures are estimates only, based on the advertised rate. You can change the loan amount and term in the input boxes at the top of this table. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.
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