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Taking a ‘fix it and forget it’ approach with your mortgage could cost you thousands. Your mortgage is a long-term commitment. During the tenure of your home loan, your personal and external circumstances could change significantly. You may want to increase your repayment size in the wake of a pay hike, or you may wish to close your home loan sooner by putting in funds from a windfall gain. Whatever your motivation, refinancing gives you the flexibility to take charge of your mortgage. The most significant and obvious benefit is the instant funds refinancing adds back into your budget, leading to an immediate increase in your purchasing power. To make the most of refinancing, you must, however, ensure that you switch to the right loan. While there are undisputedly multiple factors you need to keep in mind while refinancing, here are three critical aspects we believe every borrower must consider before making a switch.
1. Loan Tenure
Most borrowers tend to be influenced by a low rate while making a switch. Considering the tenure of your new loan is just as important. Switching to a lower rate loan with a longer-term could leave you financially worse off in the long run. Here’s an example.
Let’s assume you have a home loan with an outstanding loan amount of $450,000 remaining. When you took the loan out six years ago, it had a tenure of 25 years.
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You are now only 19 years away from paying your loan off.
Further, the current interest rate on this loan is 3%, with no on-going fees. Under this facility, you would be paying around $2,592 per month. Now, let us assume you refinance the $450,000 loan to another loan with a 3% interest rate, but for a 30-year loan term. The new repayments are $1,897 per month. It looks like a significant savings of almost $700 per month! Unfortunately, you are financially worse off in the long run. Your immediate cash flow has improved, but this is costing you more interest. How is this possible if the interest rate is the same! In this example, the existing loan is much cheaper in the long run, with only $140,915 in interest payable. Extending the loan to a new 30-year loan term adds over $92,000 to the total interest bill. This can be the case even if the interest rate is lower.
2. Flexibility in Repayment size and frequency
Increasing your repayment size or your repayment frequency, or both gives you the ability to pay off your loan faster. Opt for a loan that lets you benefit from positive changes in your financial circumstances. The most common repayment frequencies are weekly, fortnightly and monthly. Weekly repayments are most effective in closing your home loan faster. As mentioned at the beginning of the article, you may want to make larger repayments on account of increased income or may want to put in funds from a sudden inheritance. By closing your loan sooner, not only do you expedite property ownership but also pay for lesser interest through the life of your loan.
3. Loan Features
Loan-features like an offset account, split loan options and redraw facility are crucial for savings and quickening homeownership. Understand how each of these features work and how they apply to your circumstances. If you find it challenging to do this, engage a mortgage broker to help you out. Brokers get paid by lenders on the settlement of a loan, and their services are usually free for borrowers.
In a nutshell, the lowest rate offering may not be the best option for you. Ideally, you should aim at balancing long term and short-term benefits of refinancing. The most straightforward approach to this is to rely on professional guidance.
Reach us for the best way forward as per your circumstances.