Saturday, January 22, 2022

Learnings from refinancing a mortagage

The information and links provided are for general information only and should not be taken as constituting personal financial advice. You should always do your own research when making any financial decisions.

I was nearing the end of a fixed interest portion of my loan, so naturally I wanted to know what my options were going forwards. This post records some of the learning through the process.

Background

Before I continue, it is worthwhile establishing my situation, which will very likely be different to yours!

• I live in Melbourne (Victoria, Australia)
• I had financed the purchase of a property in 2020
• The property I purchased is my principal place of residence (PPOR) 1
• When I purchased the property I had a loan to value ratio (LVR) 2 of >80%, which meant I had to pay for lender's mortgage insurace (LMI) 3
• Repayments were for the principal and interest
• The loan had an initial fixed term of 2 years, rolling over to variable afterwards

Preparation

Before starting, the lender will need to know following objective information:

• Outstanding balance of the loan
• Length of loan
• Current interest rate
• If you are rolling over to variable after a fixed period, use the variable rate
• Estimated property value, you can use estimators from REA4 and Domain5

From this we can calculate the loan to value ratio (LVR) 2:

${LVR} = \frac{Outstanding Loan Amount}{Estimated Property Value}$

The higher the LVR, the more risky the loan. A key threshold is having ≤80%, this opens up opportunities for lower interest rates and typically not needing to pay lender's mortgage insurance anymore.

It it also worth thinking about what kind of loan you want. Consider:

• Do you want a fixed interest rate? How long to lock in a fixed term?
• There are break-costs6 to ending a fixed term early.
• Consider your future plans with the property? Do you intend to sell soon, if so, maybe a variable rate or a short fixed term would be best.
• Have an emergency fund 7 in cash? Put it to work against the mortgage!
• Most variable loans offer an offset account 8, it behaves like an everyday savings account but instead of earning interest, the money inside the account offsets the loan principal - reducing your interest payment
• Most loans also offer a redraw facility9 which appears to be similar to an offset account, but it is not suitable for emergencies as it is technically the bank's money - not yours10
• Does the lender let you split the loan?
• Most of loan should be fixed at a lower rate, while a portion is variable to take advantage of an offset account

Weighing the options

Considering the following options:

• Do nothing
• The loan continues with the current lender, typically rolling over to a variable rate
• Negotiate with current lender
• Look elsewhere

Do nothing

In most cases, you will rollover to the variable rate the lender is currently offering for your mortgage. Always call the lender to confirm the interest rate, as it may be different to what is on the website!

This is the easiest and not wrong in some cases!

Consider the scenario where you are at the edge of an 80% LVR. In a few more repayments, you will be under that threshold where better refinance options open up. In the meantime, you don't want to lock yourself into a subpar fixed term loan. At the end of the day, you will just need to know your options and do the maths.

Negotiate with the current lender

Most lenders are keen to keep you on board, so don't count then out - talk to them! Discuss what you wan't your loan to look like going forward.

Look for another lender

This is where things get the most interesting.

Costs and Fees

• ❗ Lender's mortgage insurance (LMI) for LVR > 80%
• This is paid to the new lender
• It is not transferrable, so even if you have bought it for your current lender, you will need to buy it again for the new lender
• LMI is the most significant cost and can outweight any advantage the new loan offers
• For even just an LVR of 81%, 1% off not having to pay it, you will be looking at ~$250011 • Avoid this by getting your LVR below 80% • Establishment fees • This may need to be paid to the new lender • In a lot of cases, to be competitive, lenders have forgone these fees • I considered this as a few up front costs • Establishment fee - someone needs to cross the t's and dot the i's • Valuation fee to get the estimated value of the property • Break costs6 maybe a applicable when you are exiting a fixed term loan early • This is paid to the previous lender • This is higher the more months left until the end of the fixed term • I was quoted ~$300 with 1 month remaining, but consult your mortgage agreement and lender
• Avoid this by coordinating the next loan to start after the current fixed term ends
• If that is not possible, balance the cost of the break costs and moving to the new loan after rolling over to a variable rate in the current loan
• Discharge fees from the lender
• This is paid to the previous lender
• Not all lenders have this
• Worth knowing if your prospective lender has this, if you plan to refinance again later down the line
• Expect to pay ~$3501213 • Unavoidable • Government charges for registering and deregistering a mortgage • Paid to Victoria Government to process the paperwork around the mortgage •$121.4014 twice (\$242.80)
• Unavoidable

What to look for

• Better interest rates
• When the interest rate is low and this is the forever home, it is the perfect time to lock in a competitive fixed term loan
• Typical rules of thumb
• The longer the fixed term the higher the interest rate15
• The lower the LVR the lower the interest rate16
• Interest rates are higher for investment properties, i.e. not principal place of residence (PPOR)
• Offset account
• Only available on variable loans
• Whether you can split the loan to have a portion fixed and the remaining as variable in order to get an offset account
• Pay attention to any ongoing fees or conditions to have such an account17
• Low or no fees
• Pay attention to any ongoing fees for the loan18
• Cash bonuses and incentives
• Some loans come with a cash bonus19 or other incentives for refinancing
• Be sure to look that this truly outweighs the cost to move, especially if you have to pay lender's mortgage insurance
• Unique scenario where someone held onto a loan with a very low LVR, profiting by refinancing it every year to take advantage of cash bonuses20