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Taking out a mortgage is an inevitable decision for millions of homeowners. This substantial amount of debt often spans a considerable period of time in your life. Average home loans last from 15 to 30 years. It, therefore, comes as no surprise that you need to make smart decisions. Especially when it comes to making expensive long-term investments. This includes the financing of your home or an investment property.
What exactly is refinancing? It involves paying off a current loan and acquiring a new mortgage to replace that one. Refinancing offers enticing financial benefits. Benefits include lowering your monthly payment or increasing equity, but it can also require thousands of dollars in closing costs.
In Australia, many homeowners refinance every few years in the hopes of saving significant money. Usually with the help of their mortgage broker. To help you reach an informed decision and ultimately improve your financial position, consider these common reasons for refinancing.
Getting a Lower Interest Rate
When you refinance, you may be able to take advantage of lower interest rates to reduce your monthly mortgage repayment. For example, a $300,000 mortgage with a 20-year fixed interest rate of 7%, your monthly payment would be around $2,300. If you refinance this mortgage at a later date and qualify for a 4% interest rate. Your monthly loan payment becomes $1,800, which translates to a saving of $500 each month.
it’s good to refinance when you get an interest rate that’s at least 2% lower than your existing rate. Nonetheless, some lenders insist that a 1% difference can help you save considerably. When you qualify for a lower interest rate, your monthly payment becomes less expensive. This may help you save hundreds of dollars each month, depending on the size of your loan. Remember that the term of your loan is an equally critical factor to consider. Even if you get a lower monthly payment, your savings may be nullified if you refinance to a longer term.
Changing to a Different Type of Mortgage
Variable-rate mortgages typically offer better rates compared to fixed-rate mortgages. However, when the Reserve Bank of Australia (RBA) begins increasing the cash rate, this typically results in your bank increasing the interest rate on your variable-rate loan. It may make sense to shift to a fixed-rate mortgage to obtain an interest rate that isn’t subject to change with rate increases. A fixed-rate mortgage also gives you the assurance that your existing rate won’t skyrocket in the coming years and your monthly payment amount will remain consistent.
In contrast, if you currently have a fixed-rate mortgage, you may want to switch to a variable-rate mortgage if there’s a continuous trend of declining interest rates. Periodic adjustments are in your favour, as your interest rate will keep decreasing and your monthly payments will become smaller. Changing into a variable-rate mortgage may be a smart financial move if you don’t intend to live in your home for the long term. If you plan to stay in your home for only a few years and the rates keep dwindling. You’ll benefit from a reduced rate and more affordable monthly payment. This will relieve stress over possible rate hikes in the future.
Taking Cash Out
Traditionally, refinancing involves replacing your current mortgage with a new loan, but the balance stays the same. In comparison, drawing equity out of your home means you obtain a new mortgage that’s higher than your existing debt. You can then take the difference between your existing and new mortgage in cash. Homeowners typically consider this option to pay for major expenditures, such as a home renovation project.
Mortgage interest rates are tax deductible and typically lower compared to other loan sources. The catch, however, is that taking out another loan and lengthening your term bring the risk of getting trapped in a frustrating debt cycle. There’s also still the risk of foreclosure if you default on payments. It’s crucial that you manage your finances responsibly and always pay on time if you don’t want to end up in debt, or worse, lose your home. If tapping equity isn’t your last resort to cover a major expense, it’s best to save up for several months in an account that’s intended for a specific purpose. This can be for renovation plans, travel costs, or paying down debt.
Building Home Equity Faster
Falling interest rates give you the opportunity to shorten your loan’s term and thus speed up the process of building your equity. Shifting to a shorter term is a smart choice once your financial standing has consistently and considerably improved. Check if your credit score has increased. Ideally, a credit score of 760 or higher qualifies you for the best mortgage rates. Nonetheless, it’s important to make sure you can afford a shorter, more expensive loan in line with your goal of increasing equity in your home. You may want to create an emergency fund first to cover several months of expenses before switching to a higher mortgage payment.
With a good interest rate and term and for the right reason, refinancing can be a sound financial strategy for homeowners to save money. Make sure to evaluate your cash flow, income, and debts carefully, and understand how the new mortgage will affect your financial situation. Define your financial goals, whether you intend to pay off your loan in a shorter period or aim for a consistent monthly payment over the long haul.
More importantly, keep in mind that you’ll have to pay for hefty closing costs, which are usually around 3% to 6% of the loan, so it’s important that you make the right decision the first time. You may want to use an online mortgage refinance calculator to find out how long it will take to recover the costs. When you take time to examine your finances, determine your reason for refinancing, and compare the benefits versus the costs, you will usually be able to avoid the common pitfalls associated with refinancing and save yourself from exasperation later on.