Do you need to refinance sooner rather than later? It may depend on your equity

The Reserve Bank of Australia (RBA) has hiked the cash rate multiple times since May 2022, bringing it from its record-low of 0.10% to nearly 4.00% in less than 12 months. Homeowners on variable home loan rates are no doubt feeling the pinch in their budget. 

In fact, RateCity research shows that after February’s rate hike, variable rate mortgage holders with a loan balance of $750,000 may be paying $1,362 more in mortgage repayments than they were in April last year. This may cause significant financial stress for homeowners, particularly those who purchased property at the edge of their borrowing power when rates were low. 

One of the ways homeowners may ease this financial burden is to consider refinancing to a lower interest rate. With three of the four big four banks predicting that the cash rate will peak at 4.10% in May, there is a growing sense of urgency for homeowners to refinance before their mortgage costs climb beyond their capacity to meet them. 

Meanwhile, if you’re one of the many Australian homeowners that fixed their mortgage rate when interest rates were at record lows, you may be bracing for the upcoming end of your fixed term. At this point, your home loan will either revert to a much higher variable rate, or you could refinance to a new - also much higher - fixed rate. 

This shift from low fixed rates to higher ongoing rates is being referred to as the ‘fixed rate cliff’, and has the potential to impact a total of $99 billion worth of mortgages from CommBank and Westpac alone. 

The peak of this fixed rate cliff is predicted to be in the second half of 2023. If the cash rate rises to 4.10%, which it has been predicted to hit by May, these borrowers are looking at revert rates of over 7.00%. One way to avoid paying a much higher revert rate on your home loan is to refinance to a new, lower interest rate.  

So, if refinancing is a potential silver bullet for rising interest rates, shouldn’t every homeowner be able to consider this option? Not necessarily. This is for a number of reasons, one of which being the equity in your home. 

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How does equity affect your ability to refinance?

When you apply to refinance your home loan, the lender will typically revalue your property as part of the assessment process. This is done as part of your eligibility assessment to accurately assess the loan-to-value ratio (LVR) on your mortgage.

In most cases, the lower the LVR, the lower the risk of the borrower defaulting, and vice versa. An ideal LVR is considered to be 80% or lower, with mortgage lenders typically accepting LVRs upwards of 90%, and 95% in some instances.  

The amount of equity (the difference between the property’s current value and the mortgage balance remaining) you have in your home impacts your LVR. A mortgage lender will want to ensure you have some equity in your home before it can approve you for a refinance as part of its risk assessment.  

However, when property prices fall, as they have done for almost all capital city dwellings annually, this decreases the value of your home, therefore decreasing your equity and increasing your LVR. 

For homeowners who purchased property in the last few years, there is a high risk that you have less equity than you think due to falling property prices.And if a homeowner’s equity falls into negative territory, a lender will be unlikely to take them on as a new customer, meaning they may be stuck with their current lender. 

Meaning, you may struggle to gain approval for refinancing, or you could have to pay Lenders Mortgage Insurance (LMI) again if you do refinance - which can be tens of thousands of dollars. Recent first home buyers are particularly at risk of not being able to refinance, as this group is more likely to enter the market with a deposit under 20% just to get a foot on the property ladder. 

Should you refinance sooner rather than later?

So, if interest rates on home loans are rising and property prices may be falling, should homeowners be considering refinancing sooner rather than later? 

The answer may depend on your home loan interest rate and your available equity. You may want to perform a Property Value Estimation to determine if your home has fallen in value. If it has fallen significantly, you may need to consider holding off until values rise again or you boost your equity through paying down your loan principal.  

If you do have equity in your home and your LVR has not risen too high, you may consider refinancing sooner rather than later if:

• Your fixed rate term is coming to an end

When your low-rate fixed period ends, you may find your lender puts you on a much higher revert rate. If you are 1-3 months away from your fixed rate period ending, it may be worth considering refinancing sooner rather than later, before you have to pay these much higher costs. 

By refinancing to a lower-rate lender, whether you opt for a new fixed rate or a variable rate, you could protect your household budget from significantly more expensive mortgage repayments.  

• Your current variable rate is causing financial stress

One option homeowners have when interest rates are rising is to consider refinancing to give themselves a rate cut. Mortgage lenders often reserve some of their most competitive interest rates for new customers, and one way you can nab these lower rates is to become a new customer.  

If your household is facing significant financial difficulties due to rising mortgage rates, one option to consider may be to refinance before the cash rate climbs to 4.10%. You may also be able to speak to your lender about lowering your interest rate, look at making extra repayments on your mortgage to chip away at your principal owing, or even consider utilising your offset account to help reduce your interest charges.