When living costs are high and interest rates are dropping, more of us choose to refinance our home loans. But doing this the wrong way could end up costing you more than you save.
As interest rates trend downwards, everyone wants to ensure they're getting the best possible deal from their lender and ultimately, reduce their monthly payments. And many banks will be actively competing for refinancing business.
The Reserve Bank of Australia has slashed the cash rate for the second time this year to 3.85%, marking their lowest level in two years, with future rate cuts on the cards.
"In this rate-dropping market, a lot of banks will claw back a bit of margin,” explains New South Wales-based Mortgage Choice broker Duane Mengel. “They will drop the rates, but not necessarily across all of their products."
But when refinancing goes wrong, what starts as a cost-saving strategy can quickly become a financial pitfall, he warns.
"You want to make sure your money is working hard for you, but I certainly see plenty of mistakes when it comes to refinancing."
Here are some common pitfalls to avoid when taking out a new mortgage.
1. Don't always opt for a fixed-rate loan
During a downward rate cycle, most people opt for variable rate home loans to potentially benefit from lower repayments as interest rates decrease.
If you're tied to a fixed-rate mortgage, you won't get to enjoy those reduced payments, and switching to a variable rate mortgage can incur substantial costs if you break your fixed-rate term.
"Breaking fixed rates can cost you a lot of money — sometimes even more than what it's worth to refinance," Mr Mengel explains.
While a fixed-rate mortgage may offer lower interest rates at the moment — simply because it's less attractive — think before you lock yourself in, he adds.
"Fixed rates should be used for certainty, not to save money."
2. Don't consolidate all your debts into your mortgage
Mr Mengel has seen many individuals eager to consolidate their debts into their home loan during the current cost-of-living crisis to reduce monthly repayments and free up cash.
Mr Mengel warns that consolidating all your debt can lead to a less than ideal outcome. Picture: Getty
But this strategy can end up costing you more in the long run, he says.
"People may want to consolidate a credit card debt or a car loan. However, if you include a car with a five- to seven-year lifespan in a 30-year mortgage, it will be long gone when you're still making payments on it.
"Putting those personal debts into your mortgage can be a bad thing if you're not increasing your repayments to pay that portion of the loan off quicker."
3. Don't refinance too many times
Banks can dangle all kinds of carrots to attract your business (though cashback offers have largely become a thing of the past). But Mr Mengel says refinancing too frequently can negatively impact your credit score because you're applying for new credit.
"People can find themselves in a situation where their credit score is so low that they actually can't borrow money anymore. Don't let short wins get in the way of long-term cost."
A good mortgage broker will conduct annual reviews to ensure you're always getting the best deal.
4. Don't go mad with Buy Now Pay Later
Signing up for any type of credit, whether for a mobile phone plan or a utility, will also lower your credit score. This is especially true if you miss payments or make late repayments. Buy Now Pay Later (BNPL) services have the same effect.
"Every time you apply to pay for something in arrears, whether you actually take out the loan or not, your credit score will drop," Mr Mengel warns.
"It's really scary when I see people using BNPL for everyday items like groceries to try to make their money go further, which actually then hurts their credit score and impacts their potential borrowing capacity."
5. Don't rush the process
Banks don't tend to lower their rates willingly when you request it and may only do so at the last moment once you've submitted the discharge form.
"Banks make it really hard when it comes to discharging mortgages, especially for a refinance,” Mr Mengal says. “When they don't give the best rate upfront, it's frustrating for both customers and brokers.”
Some lenders also take longer to approve loans than others. He advises those looking to refinance to allow at least two weeks for the process.
6. Don't choose an offset account if you can't save
"Sometimes the right structure will actually serve you better than the lowest interest rate," says Mr Mengel.
For example, many banks impose higher interest rates and/or additional fees for an offset account. While this can be an excellent tool for paying off your mortgage faster, if you're living paycheck to paycheck and lack extra funds to save, it could cost you more in the long run, he warns.
7. Don't choose a long loan term if you don't have to
Mr Mengel advises homeowners not to refinance back onto a 30-year loan term unless they absolutely need to.
Signing up to a 30-year loan when your refinance will mean you end up paying more in interest in the long run. Picture: Getty
"It may offer lower rates and repayments than a 20-year loan, for example, but you'll end up paying more interest. The quicker you can pay off the loan, the more money you'll save."
If people do take a longer loan term, he recommends ensuring there is flexibility to pay it off earlier if they want or need to.
A good broker can calculate what a mortgage will cost you over different loan terms, factoring in all the fees and interest.
8. Don't restructure if you're planning on selling
If you're planning to sell in the future, refinancing may not be worthwhile, Mr Mengel acknowledges.
"Stay where you are, get the property ready for sale, and sell it, rather than refinancing to obtain a lower rate when you'll only have to close the loan when you sell the property," he adds.
"In this case, restructuring can actually cost you for no reason."
9. Don't forget to consult your broker in advance of changes
If there's a change in your financial circumstances — such as having a child, changing your income, or starting a business — it's important to consult your broker in advance to understand how this might impact your borrowing capacity and whether refinancing is the right decision.
"There's often a different set of rules we have to play by," Mr Mengel says. "If people have gone too far down the track, it can be too late to help them.
“For example, if they're missing repayments, they may not be able to keep their mainstream lender and we may have to consider non-conforming lenders that take on more risk than a normal bank but often charge higher fees.
"It's so important to find a mortgage broker you like and trust who can lay out all your options."
This article first appeared on Mortgage Choice and has been republished with permission.
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