Tactics to consider when refinancing your mortgage: Cameron McEvoy

Last week, I mentioned how now is a great time to refinance, and listed some general considerations to costs involved when refinancing and identifying whether it is worth it to switch or stay put.

Today I want to take that one step further and (assuming you have calculated it is worth your while to refinance) present some tactics to consider when refinancing and the kinds of setups you might want to consider. I’ll then illustrate how these tactics can work with an example.

Before I do that though, I must mention up front that I am not a finance expert, nor do I have any qualifications in financial planning whatsoever, so I cannot offer any advice whatsoever regarding finance strategy.

Please do not take my examples and tactical suggestions as financial advice specific to you; instead this is more generalist tactics that I urge to you at least consider in your decision making process. So, whilst I’ll aim to answer questions such as:

-          Do you fix the lost?

-          How much do you fix and how much do you leave as variable?

-          Do you cross collateralise or not?

I can only offer a view on such questions. The truth is, every situation is different, so these are decisions you must make and seek professional advice on. All I can do is share some things that have worked for me on my journey. I am keen to hear from others who have employed successful refinancing strategies within their portfolios, as well as any criticisms of the tactical approach I mention below.

With that said, I would suggest you consider some of following tactical examples. Where possible I try to use fictional examples because it is easier to explain things in that way.

1) Know your short, medium, and long term goals within a property investment context

And I don't mean wishy-washy 'life goals' such as ‘I want to retire at age X’ or ‘I want to have enough money to go on a holiday every year’. These kinds of goals are important for us all, but to realise those big bold ones via tactics like property investment, you need to break that down into specific goals within purely your property investment life. Knowing where you want to be during these timescales will help infer your course of action.

2) Consider the type of loan product split that is right for you

As an investor and not a home owner, you should consider majority-fixed mortgage products due to the great rates on offer and the short-term (say 2-3 years) security that a majority-fixed loan at such a low rate, offers you. This is especially true if you are in an acquisition phase of your property investment life. Having the security of (mostly) fixed repayments for a couple of years means you can know your plan what buckets you allow your income streams to feed into, and enables you to park dollars in other places that you will have saved whilst on this short term phase. This could result in you being enabled to acquire more properties during the coming years more quickly than before.

 

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3) Think about what happens to the fixed portion of any loan product, when it ends

So you are refinancing to a new 25 or 30 year mortgage, with a great fixed rate on a big portion of that loan. However, the fixed rate expires in only a couple of years (say five years maximum). It is critical to negotiate and agree a good deal for that fixed portion when its term ends. Normally, a fixed portion simply reverts to a variable loan, and gets the rate-of-the-day for that variable portion. You need to be mindful of this and where possible, negotiate a good variable rate incentive (say, a portion of discount on whatever their standard variable loan rate is, at the time), for when the fixed rate portion expires.

4) Consider the 'true benefit' of fixing a majority portion of a loan for that time period

Even though I am not a finance expert, I can tell you that as an investor, no planner will ever recommend you fix 100% of your mortgage(s). That is simply not a smart move. In my view, the strategy that has worked for me during my pre-refinance calculations is this: Only leave as a variable portion, a percentage of the overall loan amount that enables the benefit of an offset account’s maximum value usage. This maximum usage can really only feasibly be an amount either equal to, or slightly greater, than the cash amount you could save up yourself, within that fixed rate period of the overall loan. What on earth does that mean, I hear you think? Let me illustrate with an example where I will attempt to simplify it:

-          Let's say you have one investment property that carries a $300K loan, and you are considering switching to a loan where you can get a great rate fixed for two years

-          As an investor you know the value of having an offset account already, so you know you want one on your new mortgage product with the new lender

-          Let's say your current annual income salary after tax is $45K. Out of that, after deducting living expenses and commitments, as well as all holding costs on the property - including interest repayments, rates, management costs and so on - and allowing for things like holidays and other purchases, you figure you'll have save say $15K of your salary per year

-          This means over that first 2-year period of that fixed rate deal, you'll probably save no more than $30K cash. Assuming you park all of this in your offset account, this means that at month #24 of the new product, you'll have the offset benefit of $30K of 'loan' that you avoid paying interest on. Happy days!

-          The way an offset account works means that there is no point having one, if it is not able to offset at least as much as you would be able to put into it. I.e. if your variable loan portion was only $20K of your $300K mortgage, the offset is only good for up to $20K of value, meaning that if you had $30K of savings, you’d have $10K that would have to sit in your regular savings account, doing sweet-nothing to reduce interest on $10K’s worth of mortgage repayments.

-          So, to help infer how much of your new mortgage you'd want to fix at a great rate and how much you'll leave variable (I.e. up to the 'chance' of variable rates staying low too, over two years!), you should leave as the fixed amount, say 10% more than the maximum you feel you could save during the period, as a neat buffer to work with

-          For this example, the person should really consider a variable loan portion of $33K ($30K maximum savings achievement plus 10% buffer). This makes the ratio of variable product overall, about 11%, meaning that 89% of the remainder of the loan product ($267K) should be fixed - if the fixed rate on offer is super-duper of course!

In my personal circumstance I am actually in the settlement phase of fixing a big portion of my entire portfolio for two years. My personal ratios for this period will be 87% fixed, with 13% variable.

I know that for that variable portion: over two years I'll probably only be able to save about 9-11% of that 13%, meaning I'll maximize my offset benefit whilst still allowing a buffer either side.

I have also ensured that at the end of the two years, that 87% fixed portion can be either renewed for another fixed period (if I feel rates are favourable to this arrangement), or it will revert to a variable rate that has already been pre-discounted for me, for when that day comes.

To conclude this two-part piece, my fundamental recommendation when refinancing your investment property mortgage(s) is really very simple, and involves just two things:

1)      Do your maths and find out if it is worth it to switch

2)      If switching, make sure you get a produce and access to account features that enable you to take advantage of the cheap rates of interest, in order to unlock more wealth to acquire more property.

Cameron McEvoy is a NSW-based property investor and maintains a blog, Property Correspondent.