Pros and cons of refinancing

Refinancing your home loan is a big decision, so it’s vital to consider the pros and cons and understand the different types of refinancing available. 

Whether you’re after a better deal or different features, refinancing your home loan to a lower rate can help reduce your mortgage repayments. But it’s important to note that refinancing is not without its costs and risks. 

Reduce your mortgage payments

One of the main draws of refinancing is lowering your monthly mortgage bill. Using a mortgage repayment calculator, we can see that the difference between a 6.50% p.a. and a 6.00% p.a. interest rate is a saving of $154 per month, on a $500,000 loan paid over 25 years.

Reduce the total amount of interest you pay 

Refinancing to a lower interest rate doesn’t just have the short-term effect of lowering your monthly repayments. It can also save you big bucks over the long term. 

For example, if you had a $500,000 loan and paid 6.50% p.a. interest on it for 25 years, you’d pay double in interest than your initial loan balance by the time you’ve finished paying for it – $512,811. 

Refinancing to a 6.00% p.a. rate would cost you less, at $466,452 – a saving of $46,359.

Access your home equity 

Home equity refers to your loan-to-value ratio (LVR), the percentage of the property value you own rather than the lender. 

Typically, you build up your home equity as you pay down your mortgage because you own more of the house. This makes your LVR come down and is a great bargaining chip for lower interest rates. 

Home equity can also be used to:

• Purchase an investment property
• Pay for renovations
• Invest in shares 
• Buy a new car. 

Shorten your loan term

When you refinance, you can often choose a new loan term length. For example, you might shorten your loan term from a 25-year loan to a 15-year loan. 

Remember, a shorter loan length may mean your repayments increase. But, if you’re in a position to do so, paying off your loan quickly can save you from paying some of the extra interest that accrues with time.

Change the type of rate you’re on 

If you’re on a fixed rate and want to switch to a variable rate, or vice versa, refinancing is one way to do it. 

Obviously, this is where the costs of refinancing can come into play, especially if you need to pay a fixed rate break fee.

Risk of losing equity 

Depending on the type of refinancing you opt for, you run the risk of reducing your home equity. This can mean, for example, you won’t qualify for the most competitive rates from your new lender.  

For example, if you have $100,000 in equity and take $30,000 out in cash out refinance, you’ll only have $70,000 equity left.

Risk of not qualifying for a new loan

Just because you qualified for your first mortgage, it doesn’t necessarily mean you’ll be approved for refinancing. 

Circumstances change over time and if your refinance application isn’t approved it will impact your credit score, which could make it harder to receive a lower interest rate in future applications.

The cost of refinancing 

From discharge fees to application fees, there are plenty of costs to refinance that you will want to weigh up. You might do the math and find you won’t save all that much by refinancing, once the fees are added up (especially if you’re breaking a fixed-rate contract). 

Monthly repayments could increase

If you refinance to a shorter term loan, your mortgage repayments will likely go up because you’ve reduced the time you have to pay off your loan.

Typically longer loans have smaller monthly repayments, but you accumulate more interest over the life of the loan. This is worth weighing up. With a shorter loan, you might pay less interest, but your repayments can be significantly larger.

Should I refinance my home loan?

When refinancing, weighing the pros and cons is essential. It’s also smart to get in touch with a professional financial advisor, who will be able to help you understand your options.

If you need more information about refinancing check out Mozo’s home loan guides, or, if you’re at the research stage of your refinancing journey, compare refinance home loans today.