Refinancing your home loan can take a huge weight off your interest repayments or even provide some financial freedom through making debt consolidation possible. Regardless of whether you’re looking to achieve a healthier cashflow or access funds to finally start realising your renovation dreams, your home’s equity is going to underpin the entire refinancing process.
Most loans allow you to borrow up to 95% of the home’s value. This is the Loan to Value ratio (LVR). If you are thinking about refinancing your home loan, you’ll need to have at bare minimum 5% of the home’s value in equity. However, refinancing an amount above 80% LVR will mean that you have to pay Lenders Mortgage Insurance (LMI) which can add thousands to the cost.
If you have 20% or more in equity, you are able to refinance without having to pay LMI. If you are wanting to refinance with equity between 5-19%, you’ll need to consider if the savings outweigh the cost of having to pay thousands of dollars in LMI. Also, keep in mind that anyone with about 5-10% in equity generally won’t be able to access an LVR of higher than 95%. This is important to keep in mind if you’re wanting to access equity for home renovations.
Refinancing to unlock your equity is a great way to access funds to use for home improvements. It works as follows:
Let’s say you have a $500,000 home and have accumulated 40% equity ($200,000). You would like to spend $100,000 on renovations, so you decide to refinance your mortgage. Your current loan to value ratio is 60% (you owe $300,000 on a home worth $500,000). To access $100,000 you refinance the mortgage to an LVR of 80%. Which basically means you now have a home loan of $400,000 to repay, and you have unlocked $100,000 to use for renovations.
Now consider the same scenario, only you want to take the maximum amount out of your equity to use for major renovations. The maximum LVR is 95% which means that the refinanced loan would be for $475,000. This means you have accessed 35% of your equity ($175,000) which will now be repaid on top of the initial $300,000 debt. Because the LVR has gone above 80%, LMI is payable. On a loan of that size, at 95% LVR, the Lenders Mortgage Insurance payable is approximately $17,500.
In scenario B, you end up accessing a lot more money to use for renovations, but the LMI expense is high. You can significantly reduce costs by keeping the LVR below 80%.
LMI was introduced to help Australian’s access home loans if they didn’t have the traditional 20% deposit. It is an insurance policy that forms part of the cost of your home loan and helps protect your home lender if you can’t afford to meet your home loan repayments. So, if you are one of the many Australians with an LVR of over 80%, then yes, you will need to pay Lenders Mortgage Insurance.
One of the downsides for borrowers is that Lenders Mortgage Insurance is typically non-refundable and non-transferrable. Meaning that if you’re looking to refinance and don’t have at least 20% equity, chances are you will need to pay LMI again.
Your offset account balance will be reducing the interest charged on your home loan but does not actually count as equity until you pay that amount off your home loan principal. What this means is that if you want to refinance your mortgage to access a lower interest rate, or a home loan with better features or more flexibility (without withdrawing the equity you have as cash money) the amount you have in your offset account won’t count as equity for the purposes of refinancing.
If you choose to use those funds to make a home loan repayment, then this will obviously grow your equity as it pays down your actual loan balance (but then of course you lose access to these funds). That being said, if you want to access equity to be able to pay off debt, consolidate debt, take a holiday or make a large purchase – you can use the funds in your offset account to do so, potentially without the need to refinance at all!
Having a clear objective or goal in mind for refinancing can help you stay on track instead of potentially turning down a path of temptation. What could start out as an intent to lower your interest rate could end up needlessly spending your hard-earned equity simply because it’s accessible. By knowing why you want to refinance, you have a better chance of preserving equity in your home.
Gain Access to Extra Funds
Refinancing is one way to access the equity in your home without the need to sell it.
Home loan interest rates are nearly always the lowest interest rates of any loans, making a refinance an attractive option for debt consolidation. You may also be able to save money purely through refinancing to access a lower interest rate.
Increase in Value to your Home
By refinancing to renovate, you could potentially add more value to your home than the equity you’ve used to renovate it!
A refinance could mean larger repayments
If a refinance for you means increasing the loan balance, then despite a potentially lower interest rate, your repayments may increase
Your debt increases
If a higher loan balance is the result of a home loan rebalance, it means your debt increases, which could impact your ability to borrow further money or your insurances.
There are costs involved
Most notably, you may need to pay Lenders Mortgage Insurance again, but there could be fees and charges for refinancing which may absolve some of the benefit to refinancing in the first place.
If you’ve worked hard to pay down your home loan, or your home has risen in value, by using that equity means you now need to start that process of repaying again and waiting for your home to increase in value
When calculating your home’s value for a refinance, your lender won’t look at the projected value after completed renovations. The bright side is that if your renovations do increase the value of the home, then hey presto, you’ve instantly built more equity
Your home’s equity won’t be the only thing that’s changed since you originally applied for your home loan. An application for a refinance is an application for credit, so make sure that you know your credit score is in good health before applying.
It also pays to know how any change in income, employment or personal situation may affect your eligibility to apply or likelihood of approval.
In many cases, a refinance makes good financial sense, however, be sure to calculate the total cost involved in refinancing before you decide it’s the right decision for you.