Rising interest rates can create uncertainty for homeowners with a mortgage. When rates rise, the cost of borrowing increases and monthly repayments become more expensive. In this environment, refinancing can seem like a questionable move. However, the decision to refinance is not as simple as it seems. Understanding the potential pros and cons can help you determine whether it’s worth exploring a rising interest rate market.
Refinancing essentially involves replacing your existing mortgage with a new one, either from the same lender or from a different institution. The top reasons people refinance include getting a lower interest rate, accessing equity, consolidating debt, or adjusting the loan term. Before diving in, understand concepts like meaning of LVR (Loan to value ratio) is crucial. LVR, which measures the percentage of your property value you borrow, plays an important role in determining your refinancing options and the terms available to you.
Why consider refinancing when rates are rising?
Although refinancing may seem counterintuitive in a rising rate environment, there are several situations in which it could still make sense:
Lock in a fixed rate
If your current loan is an adjustable rate and interest rates are expected to rise further, refinancing to a fixed rate loan can provide stability. Fixed rates lock in your repayments for a set period, protecting you from future rate increases.
Switch to a more competitive loan
Even with rates rising, not all lenders adjust their rates at the same pace. Some may offer more competitive rates or better features, such as offset accounts or fee waivers. Refinancing gives you the opportunity to shop around and find a loan that better suits your needs.
High Interest Debt Consolidation
If you have high interest debt like credit cards or personal loans, refinancing your mortgage to consolidate these debts could save you money overall, even if mortgage rates rise. Rolling these debts into your home loan typically results in a lower interest rate than unsecured credit options.
Access equity
Rising house prices in Australia mean many homeowners have built up significant equity in their homes. Refinancing allows you to access this equity for renovations, investments or other financial goals, potentially improving your financial situation despite higher rates.
Potential refinancing risks
While refinancing can offer benefits, it is not without risks, especially in a rising interest rate market:
Higher rates on new loans
If you’re currently on a low fixed or discounted rate, switching to a new loan could mean losing those favorable terms and ending up with a higher interest rate.
Exit fees and termination fees
Breaking a fixed rate loan before its term expires can result in high break fees. Additionally, the new loan may have upfront costs, such as application fees, appraisal fees, and legal fees.
Shorter loan terms can increase repayments
Refinancing to a shorter loan term, while beneficial for paying off your mortgage faster, could result in higher monthly payments.
The impact of LVR
LVR becomes particularly relevant when refinancing. If your LVR is above 80%, lenders may require you to pay lenders’ mortgage insurance (LMI), even if you have been forgiven on your current loan. This can significantly increase the cost of refinancing and could exceed the potential savings.
How to determine if refinancing is worth it
The decision to refinance depends on your financial goals and personal situation. Here are some key considerations:
Calculate costs versus benefits
Add up the refinancing costs (e.g., exit fees, origination fees) and compare them to the potential savings from lower rates or other loan features. If the benefits outweigh the costs, refinancing could be a wise solution.
Evaluate your long-term plans
Consider how long you plan to stay in your home. If you’re likely to sell or move within a few years, the savings from refinancing may not justify the upfront costs.
Understand the current terms of your loan
Review the fine print of your existing mortgage. If you’re locked into a fixed rate with high break fees, refinancing might not be worth it until the fixed term ends.
Finding the right timing
Timing plays a vital role in refinancing in a rising market. Although rates may continue to rise, acting sooner rather than later could help you avoid locking in a higher rate later. However, don’t rush the process: take the time to research your options, compare lenders, and understand the terms of any new loans.
The role of professional advice
Navigating the complexities of refinancing can be difficult. A mortgage broker or financial advisor can help you evaluate your options, calculate potential savings and guide you through the refinancing process. They will also help you understand how factors such as meaning of LVR impact your borrowing power and loan choices.
Conclusion
Refinancing in a rising interest rate market may not seem like an obvious choice, but it can still provide valuable opportunities for the right borrower. Whether you’re looking to get a fixed rate, access equity, or consolidate debt, refinancing can help you achieve your financial goals if approached thoughtfully.
Understanding your current loan, the costs involved and how LVR influences your options is essential to making an informed decision. With careful planning and professional advice, refinancing could be a strategic decision to manage your mortgage and secure a better financial future.
