What is Refinancing?

Refinancing a mortgage or business loan can be a strategic financial move, but many borrowers find the process confusing, particularly when distinguishing between refinancing and restructuring a loan. Understanding these differences, along with key factors such as cash contributions, break fees, and lender requirements, can help you make informed decisions.

Refinancing vs. Restructuring

Refinancing essentially means switching banks. You take out a new loan from a new lender (ideally on better terms) and use it to repay your existing lender. The main motivations for refinancing are securing a better fixed rate, adjusting the loan term, consolidating debt, or freeing up equity from a property. Refinancing also requires legal assistance, whereas restructuring does not.

Restructuring, on the other hand, involves modifying your existing loan with the same lender. This could include re-fixing your loan to take advantage of a lower interest rate or extending the fixed term at a moderate rate to hedge against future increases. Many borrowers closely monitor economists and Reserve Bank decisions (particularly changes to the Official Cash Rate) to predict fixed-term rate movements. However, even bankers, economists, and financial advisers have admitted to getting these predictions wrong for their own properties!

Key Considerations When Refinancing or Restructuring

1. Cash Contributions from Lenders

New lenders often provide a cash contribution as an incentive, but existing lenders rarely offer financial rewards for retaining your business. You generally won’t receive any benefits for re-fixing your loan with your current bank. However, if you switch lenders, most banks will provide a cash contribution (unless your borrowing exceeds their loan-to-value ratio (LVR) thresholds, in which case additional restrictions may apply).

2. Loan-to-Value Ratio (LVR) Implications

Be cautious when refinancing or repaying a loan if your property value has declined, as you may need to repay more than expected or struggle to secure a sufficient loan from a new lender to repay the whole loan.

For example, if you originally borrowed 80% of a $1M property ($800K loan), but the property's value has since dropped to $900K, a new lender will assess your borrowing limit based on 80% of $900K ($720K), not the original $1M. This shortfall could leave you needing additional funds to cover the difference.

Similarly, if you are selling a home but have an investment property with the same lender, they may require a higher repayment due to changes in property valuations or LVR rules, which frequently change for investment properties.

3. Break Fees and Early Repayment Costs

If you refinance while still within a fixed loan term (such as 1.5 years into a 2-year fixed term), you may have to pay a break fee or early repayment cost. These fees can be substantial, particularly if interest rates have dropped since the loan was issued.

Break fees are calculated based on the difference between your original fixed rate and the current market rate, multiplied by the remaining term. However, if interest rates have increased or only a short period remains on your fixed term, the break fee may be minimal and could be offset by a cash contribution from your new lender. Before refinancing, always factor in these costs to determine whether the potential savings justify the switch.

4. Additional Costs of Refinancing

Refinancing isn’t just about securing a lower interest rate, you must also account for associated costs, which may include:

• Legal Fees: Required to discharge your existing mortgage, register the new mortgage, and advise on loan documents.
• Valuation Fees: Some lenders require a registered property valuation, which can cost several hundred dollars.
• Body Corporate Fees: If the property is unit title, you will at least need to pay for a section 147 (pre-settlement disclosure statement which could be around $500).
• Application Fees: Some lenders charge an application or establishment fee for new loans. These can be particularly large if you are moving to a second tier lender or even a private lender.
• Discharge Fees: Your current lender may charge a discharge fee, typically around $100.

These costs should be considered in any refinancing decision to ensure the benefits outweigh the expenses.

5. Other Considerations

Many borrowers focus solely on the interest rate when evaluating potential savings but fail to account for the costs and considerations mentioned above. Additionally, some may have overdraft facilities or linked accounts tied to their existing loan, which they could lose upon refinancing. These factors should be reviewed before making a decision.

Conclusion

Restructuring is generally a simpler process, as it only involves adjusting the fixed rates or loan terms with your existing lender. Refinancing, however, requires careful evaluation of costs, lender policies, and loan features. A lower interest rate does not always equate to savings, break fees, legal costs, and potential lost benefits must all be considered.

If you’re unsure whether refinancing or restructuring is the best option for you, seek professional legal and financial advice.

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