Friday, December 2, 2011

Think before refinancing -2-

If you are thinking of refinancing to get a better deal which allows you to pay off your loan quicker you need to do your homework.

I was in the bank just the other day and the teller was asking me about my account, loans etc.  When I told her what my home loan interest rate was she hastily said “…we can do better than that. Come and sit down…..”

As it turns out they could not beat the rate, but it got me thinking.  What if they could beat the interest rate by as little as 0.06% - would it be worth the switch?  On a $300,000 loan over 30 years that is a potential saving of around $4300.  Looking good so far.
  • My current loan costs me $375 per year
  • New loan would cost me $395 per year New loan is going to cost me an additional $600 in account keeping fee over the term of the loan
There are also charges associated with the new loan:
  • Establishment fee - $600
  • Valuation fee - $450These are added up front which would actually make the total loan amount $301,050
I also took my original loan out before Exit fees were banned and would have to pay $1000 for early redemption of my current loan, but the new lender will cover the cost of the early redemption. Fantastic!

So, let’s add it all up and see where we get to:
  • Total interest saving (based on new balance of $301,050) - $2,900 saved
  • $600 extra cost of annual account keeping feeOverall saving of $2,300 in interest over the 30 year term - $75 per year saved.
Looking at the number like this would suggest that I should switch, however – if you are trying to pay your loan of quickly you may not actually save anything!  This is where you need to get a bit smarter about your calculations.

As the charges are added up front, you would only actually start saving if you were to stay with this new lender for at least 14 years.  Any less than that and the charges would out-weigh the savings on interest.

The best thing to do if you are offered a slightly better deal like the one detailed above is go back to your current lender and see if they can match or beat it.  Chances are that they will at least match it or come very close to it in order to keep your business.  Any reduction from your current lender will put you ahead so it’s worth asking the question.

This example is based an initial loan of $300,000 over 30 years at a rate of 7.5%. The savings are estimates and are not exact and are designed to be nothing more than thought provoking. The scenarios are generic and do not take individual circumstances into account. You should seek independent financial advice before making any significant changes to your financial products. .

Thursday, December 1, 2011

Think before refinancing -1-

There's no such thing as free money

There are 3 main reasons for refinancing:
  1. To free up equity – essentially borrowing more against the value of your house to give you a cash lump sum
  2. To improve your cash flow – reducing your minimum repayments to free up cash on an on-going basis
  3. To get a better deal which allows you to pay off your loan quicker
As a rule most lenders will push reasons 1 and 2 promoting the quick and ‘easy’ short term gain of extra cash. However, short-term gain equals long term pain as both these options do not actually help you pay off your loan any quicker – in fact quite the opposite. The idea of freeing up equity and/or reducing your repayments is all about keeping you in debt for longer. 

Remember that lenders, brokers and planners all benefit from your debt and it is in their interest to keep you in debt and tied to them for as long as possible.

If you are thinking of refinancing ask yourself “why?”. If you want to free up some equity or reduce your monthly payments to improve your cash flow – think twice before you sign on the dotted line.

I’m not saying “don’t do it” – just be aware that by doing so you are potentially entering into another 25 to 30 years of debt. You can afford the repayments now, but what happens when you retire and you still have another 5-10 years left on your home loan? Will your Superannuation support you and your home loan? Not likely – what happens when you are 70, retired and cannot afford the repayments on your home loan?

Make sure that you are going into it any refinance deal with your eyes wide open and don’t let anyone convince you that freeing up equity is giving you free cash – nothing is free, but the time really hits it may be too late.