Interest rates are coming down. Here’s what homeowners should know about refinancing
- Written by Ama Samarasinghe, Lecturer, Financial Planning and Tax, RMIT University
On Tuesday, the Reserve Bank of Australia cut the target cash rate[1] by 0.25 percentage points. It now sits at 3.85% – the lowest since May 2023.
Australia’s big four banks were all quick to announce they would be passing the cuts on to borrowers. If you’ve got a mortgage, you might be wondering if this is your cue to act.
Refinancing your home loan – whether by negotiating a better deal with your current lender or switching to a new one – could save you thousands over the life of your loan.
However, it won’t be the right decision for everyone. And there are some important things to know about how the process works – including hidden costs and risks.
What is refinancing?
Refinancing simply means replacing your existing home loan with a new one – either from your current lender or a different one. The goal? To take advantage of better loan terms.
If you’re on a “variable rate” loan, your lender may already be passing on some or all of the recent rate cut (though you may have had to opt in).
Read more: RBA cuts interest rates, ready to respond again if the economy weakens further[2]
But if you’re on a “fixed rate” loan, your repayments will stay the same until your fixed term ends – meaning you might not benefit from the cut unless you refinance (though break costs could apply).
Switching to a loan with a lower rate can mean smaller monthly repayments. Or, by keeping repayments the same size but with a lower interest rate, you could potentially pay off a loan faster and save in the long term.
Refinancing activity has been trending up since 2021[3], with external refinancing (switching banks) rising significantly among both owner-occupiers and investors. That’s a clear sign many borrowers are chasing better deals.
Can refinancing save you money?
Yes – if it’s right for you and you do it right. Switching to a lower interest rate could slash thousands off your yearly repayments.
If you’ve built up equity, you might be able to release funds to reinvest or improve your property. Some lenders also offer refinancing cashback deals – one-off payments to attract new customers.
There are some important things to consider – including some traps to avoid – if you’re thinking about refinancing your home loan.
1. Be mindful of your loan-to-value ratio
Loan-to-value ratio (LVR) is the amount you borrowed as a percentage of the property’s value or purchase price.
If your LVR is above 80%, you probably paid lenders mortgage insurance[5] (LMI) on your original loan, designed to protect the lender in case you default.
If your current loan still exceeds 80% of your home’s value (based on the new lender’s valuation), you might need to pay LMI again. That cost could wipe out any benefit from a lower rate.
2. Careful how you compare
When comparing rates and repayments, make sure you’re comparing apples with apples.
If you’ve already paid five years on a 30-year loan, you have 25 years left. But when you ask a new lender for a quote, they may show repayments based on a full 30-year term – which could make the monthly repayment look much lower.
To make a fair comparison, ask for quotes based on your remaining loan term. If you decide to switch, aiming for a loan with the same term can help you avoid paying more interest in the long run.
3. Factor in all associated costs
Refinancing comes with costs[7]. These may include:
- break fees if you’re leaving a fixed-term loan early
- settlement fees for your current lender to close out the loan
- application and valuation fees with the new lender
- ongoing monthly fees that might not seem large but can add up over time.
Also, if you’re applying to multiple lenders to compare offers, be aware requesting multiple credit checks in a short space of time can negatively impact your credit score.
4. Consider renegotiating with your existing lender first
Lenders rarely offer their best deals to existing customers – unless you ask. In fact, they often reserve the most attractive deals for new customers.
Consider picking up the phone and asking for a rate review. If you have a better offer from another bank, you may be able to use that as leverage.
Staying with your current lender can have advantages. It may be quicker and easier than refinancing with another lender. But don’t let loyalty cost you – especially if better rates are on the table elsewhere.
5. Don’t assume your repayments will drop automatically
For borrowers on variable loans, some banks don’t automatically reduce[8] your repayments after a rate cut. You may need to manually adjust them through your bank’s app or website, or “opt in”.
Alternatively, keeping your repayment amount the same could help you pay off your loan faster and reduce interest costs.
Banks don’t always automatically adjust variable loan repayments after a rate cut.
David Lade/Shutterstock[9]
6. Check your credit score before applying
Your credit score can play a key role in refinancing. Lenders use it to assess how risky it is to lend to you – and it can affect the interest rate you’re offered.
If your score has dropped since you first took out your loan, you may not qualify for the best deals.
Check your score through your bank or a free online service before you apply. If it’s low, take time to improve it before refinancing to boost your chances of approval and better rates.
For an estimate of your potential savings from refinancing, try the Australian Securities and Investments Commission (ASIC)’s MoneySmart mortgage switching calculator[10].
Disclaimer: This article provides general information only and does not take into account your personal objectives, financial situation, or needs. It is not intended as financial advice. Before acting on any information, consider whether it is appropriate for your circumstances.
References
- ^ cut the target cash rate (theconversation.com)
- ^ RBA cuts interest rates, ready to respond again if the economy weakens further (theconversation.com)
- ^ been trending up since 2021 (www.abs.gov.au)
- ^ Zivica Kerkez/Shutterstock (www.shutterstock.com)
- ^ lenders mortgage insurance (moneysmart.gov.au)
- ^ Joel Carett/AAP (photos.aap.com.au)
- ^ comes with costs (moneysmart.gov.au)
- ^ don’t automatically reduce (www.afr.com)
- ^ David Lade/Shutterstock (www.shutterstock.com)
- ^ MoneySmart mortgage switching calculator (moneysmart.gov.au)
Authors: Ama Samarasinghe, Lecturer, Financial Planning and Tax, RMIT University
