The old switcheroo

Anyone who refinanced a mortgage a year or so ago, when the big banks’ variable interest rates averaged 7.8 per cent, must be wondering whether it’s time to refinance again.

Home loan rates will soon be at least a full percentage point lower than in June last year following the decision on Tuesday by the Reserve Bank of Australia to cut the cash rate by 25 basis points.

Many borrowers opted to refinance last winter when fixed three-year mortgage rates dipped to a then competitive 7.38 per cent. But between November and May, the RBA cut the cash rate by 1 percentage point.

RateCity, a rate comparison web service, says that since the RBA reduced its official rate in May by 50 basis points to 3.75 per cent, the standard variable rate has been at 6.88 per cent.

That will probably fall by only 15-18 basis points now the cash rate is at 3.5 per cent because most lenders won’t pass on Tuesday’s RBA cut in full.

But with expectations of further rate cuts, more borrowers will be refinancing and focusing on variable, not fixed-rate, deals.

Demand for variable mortgages grew strongly in May, according to national loan approval data from Mortgage Choice.

A spokeswoman for the mortgage broker group, Belinda Williamson, says the RBA’s May cut, combined with speculation about further rate cuts, helped fuel borrowers’ appetites for variable loans.

According to Australian Bureau of Statistics figures, 17,756 home loans were refinanced nationally in March – the most refinanced in one month since April 2008.

RateCity spokeswoman Michelle Hutchison says borrowers are now much more comfortable switching their loans.

The ban on exit fees for new variable rate loans since July last year has worked to increase refinancing. ”It’s likely that more borrowers will switch lenders more often than in the past,” Ms Hutchison says.

If you’re considering refinancing, you first need to assess your financial goals – specifically, how long you expect to stay in your home or hold an investment property.

Some people decide it’s better to stay with their current mortgage, particularly if the savings are small or they plan to sell.

Being able to negotiate a new mortgage through a mortgage broker takes a lot of the hard work out of switching, but there is still hassle involved in refinancing. Expect paperwork and credit checks.

Also be aware that when you refinance, you’re not building equity. In fact, it’s the reverse: you’re starting at the beginning of the amortisation tables.

Amortisation schedules on principal and interest loans are structured so that almost all of your payments go towards interest in the first few years. The longer you have the loan, the more is put towards the principal.

If you want to avoid this, or lower your loan repayments for a set period, consider an interest-only loan. These offer most of the features of principal and interest loans with the benefit of lower repayments.

You don’t have to repay the principal loan amount during the interest-only period, but you have the flexibility to do so.

It’s crucial to know when the refinancing will begin to pay off.

To calculate this, start with a list of all the loan closing costs, then divide the closing costs by the amount you expect to save on each monthly payment.

If closing costs total $2500 and your monthly savings are $200, it will take you 12½ months to break even on refinancing.

If it takes you two years to recoup the costs and you intend to sell in 18 months, then refinancing does not make sense.