This fact sheet is for information only. It is recommended that you get legal advice about your situation. See the Fact Sheet: Getting Help.
What is refinancing?
Refinancing is simply replacing a loan you already have with another loan. The old loan is repaid by the new loan. It can occur with your current lender or you may go to a different lender.
IMPORTANT: Getting a loan is a big financial decision and you should always take your time to consider your options and shop around.
There are many reasons why you may consider refinancing as an option including to save money on your home loan, to borrow more money, to save money on your other loans, or because you are in financial difficulty. Refinancing can be a great way to save money, so long as you take the actual cost of refinancing into account in your calculations, but there can be many pitfalls. Refinancing because you are in financial difficulty is especially risky and you should always get advice first.
Refinancing to save money on your home loan or to borrow more money on your home loan
Refinancing to a lower interest rate on your home loan can save thousands of dollars over the course of a home loan. Sometimes, it might also be the easiest way to get more money to renovate your home or to buy a motor vehicle. Before you make a decision about taking out a new loan, you should consider the following:
(a) How much will it cost to refinance? There are many upfront fees and charges to think about including establishment fees, legal fees, stamp duty and ongoing fees, which may apply to the life of your loan on top of the interest rate. If your home loan is reasonably small it may take some time before the savings of a lower interest rate actually make up for the cost of refinancing.
(b) Remember that the interest rate is usually variable. It may be competitive now but will it continue to be competitive? You need to check how competitive the lender was in the past. Make sure you look at the ongoing interest rate, not just the honeymoon period if one applies.
(c) Check that the new loan has all the features you need.
(d) If you are using a mortgage broker you should shop around anyway. Many low interest loans are not sold by mortgage brokers. Always enquire whether you can extend your loan with your existing lender and what costs will be involved before making a decision to change lenders.
(e) If you are making a purchase such as a motor vehicle, don’t just compare the interest rate on your home loan to the interest rate on a motor vehicle loan, consider how long it will take to pay off each loan and how much interest and other fees you will pay over the life of each loan.
(f) Is the new lender in an External Dispute Resolution Scheme (EDR)? This is important because if you have a dispute you have access to free independent dispute resolution. See Fact Sheet: Dispute Resolution.
(g) Finally but most importantly, if you are borrowing more money, can you afford higher repayments or to make repayments over a longer period? If you are already struggling to pay your existing loan, you should not borrow more. Remember, your home is at risk if you cannot pay.
“Save with our special mortgage deal!”
Some businesses try to convince people who already have a home mortgage to switch to a special mortgage plan, sometimes called a debt reduction plan, or mortgage minimisation plan, to save money.
There are a number of variations on these plans but they usually involve the borrower refinancing to a line-of-credit home loan and the use of a credit card. They also invariably involve significant fees being paid to the person or business selling the plan.
As a general rule these plans will cost you more to set up than you save, involve a higher interest rate than the most basic home loan, and could land you in financial difficulty if you overspend on the credit card. If you want to save money on your home loan, the most reliable way is to pay extra on your existing loan, or refinance to a lower interest rate, not a higher one!
Refinancing to save money on your other loans (Debt Consolidation)
Refinancing several debts into one personal loan
With debt consolidation the borrower takes out a personal loan that replaces all existing debts, for example car loans, personal loans, store card and credit card debts. You will usually need at least a steady, moderate income to be eligible for debt consolidation. Many borrowers report difficulties trying to consolidate debts such as credit card accounts into a personal loan.
The advantages are:
• You only need to make one regular payment;
• You only need to keep track of one loan;
• The personal loan will usually be repaid in 5-7 years;
• The interest rate will usually be lower than say the interest rate for credit cards;
• The repayments may be lower (but they will not decrease over time).
The disadvantages are:
• It is very easy to consolidate into one loan and then use your credit cards again. If you are going to consolidate, cut up most of your credit cards and lower the limit on the remaining credit cards to an amount you can afford.
• You are at the mercy of one credit provider if you get into financial difficulty. It can be difficult to negotiate with many credit providers, but at least some may be cooperative, especially over smaller amounts.
WARNING: Some companies who advertise debt consolidation actually sell Debt Agreements (under Part IX of the Bankruptcy Act). A Debt Agreement can be expensive and has many of the same consequences as going Bankrupt. It is extremely important that you see a free financial counsellor before considering a debt agreement.
Refinancing to consolidate debts into your home loan and/or because you are behind in your home loan repayments
Being in financial difficulty is very stressful. If you are behind on your mortgage repayments, it can be very difficult to negotiate with your lender and the lender may be threatening to take your home. Even if you are managing to make your mortgage repayments, but you are being pressured by other creditors, it can seem like the easiest option is to refinance your home loan and consolidate your debts to get everyone off your back.
BEFORE YOU REFINANCE TAKE A DEEP BREATH AND THINK ABOUT THE FOLLOWING:
• You are placing your home on the line – if you cannot pay the new loan you will lose your house!
• You are cutting off options that may have been available to you such as surrendering your car (for car loans) or negotiating a reduced debt or repayment arrangement with your credit card company.
• Refinancing your credit card debts (for example) might save your skin (at least for now), but it usually won’t save you money and it won’t stop you running up more debt afterwards (particularly if you are struggling to make higher home loan repayments).
• Refinancing always costs money. If you are in financial difficulty now, you will nearly always be better off financially if you can come to an arrangement with your existing creditors. If you can’t negotiate an arrangement yourself, get advice.
• Beware of lenders of last resort – see Predatory Mortgage Lending below.
Consolidating Credit Card Debt – the truth of the matter
Consolidating credit card debt into your home loan will not necessarily save you money
While home loan interest rates are generally much lower than credit card interest rates, home loans tend to be paid off over a very long period of time, meaning you could still pay more in interest over the life of the loan. You also have to take into account the cost of refinancing. If you are refinancing just to save money, you will often be better off simply increasing the amount you pay on your credit card rather than refinancing. If you are refinancing because you cannot meet your repayments or reduce your debt – See Getting Help.
People who consolidate credit card debt often end up with still more credit card debt
Overseas research has found that borrowers who consolidate credit card debt into their home loans often incur more credit card debt afterwards, completely defeating the purpose of the debt consolidation. A 1998 study found that two thirds of homeowners who had used home equity to pay off credit card debt had additional credit card debt within 2 years. A 2005 study found that low-middle income borrowers, who had consolidated credit card debt into their home loans within the last 3 years, already carried an average of US$14,000 in credit card debt in addition to a larger mortgage.
Eli and Liz had a home mortgage for $170,000. When Eli was made redundant from his job, they fell behind with their mortgage repayments. Eli eventually found another job, but the lender said that they were too far behind in their repayments and their house would be taken and sold if they did not pay all the arrears on their home loan within 14 days.
Liz saw an advertisement advertising loans for people in financial difficulty. Eli and Liz managed to refinance their loan but it cost them over $26,000 including enforcement costs on their old loan. Their new loan also has a much higher interest rate and they are in trouble again because Liz is pregnant and will soon have to leave work. They have put their house on the market but their loan balance is now $205,000 and growing every day with default interest. Liz wishes they had sold the house a year ago, and put the extra $35,000 in their bank account.
Predatory Mortgage Lending
If you are in financial difficulty you will often be forced to go to a lender of “almost last resort” or “last resort”. There are lenders who specialise in desperate borrowers. Those lenders often advertise with slogans like: ‘bad credit-no problem”, and “sheriff at the door?”. You can tell if you are at a lender of last resort because:
• The loan term will usually be 12 months (definitely less than 5 years);
• The mortgage broker will charge you a (large) fee;
• You will have to borrow a lot more to cover all the fees;
• You will be told you have to sign a declaration that loan is for business/investment purpose even if it is not;
• They will find a solicitor for you that you have to pay.
Because your loan will increase significantly on refinance you will probably have difficulty making repayments. This may lead to you losing your home anyway (with a lot less equity left in your home)!
So what can you do?
Firstly, get advice, the earlier the better! It may be possible to negotiate with your existing lender. Even if your situation is hopeless, it may be better for your home to be sold than to refinance and increase your loan considerably just to live in it another year.
Need some more help? See Fact Sheet: Getting Help for a list of additional resources.