It's a great time to re-finance but consider the true cost of doing so: Cameron McEvoy

With interest rates at 53-year lows, and confidence returning to much of the Australian property market, it seems a smart time for not only new investors to get into the market but for existing investors to add to their portfolios.

Like many other existing investors at the moment – and despite the outcomes and revelations from the federal budget plan for the year ahead recently – I am going through the process of re-financing my portfolio. Existing home owners and investors alike should all be considering refinancing in these times of (very) cheap interest rates on offer.

However, it is important to run the numbers and make sure that you will actually be better off switching to a new lender and/or new mortgage products. If most investors are like me – i.e. working Australians on a sub-six-figure salary who have a medium to long term 'buy and hold' approach to property investing – reducing the amount of interest you pay on your mortgage(s) will be a huge priority. I would argue that the only investor types who do not value the importance of reducing interest repayments on loans would be those who are on much higher incomes ($150k plus), where they may be so negatively geared that it is more beneficial for them, year-to-year, to pay more interest due to the tax benefits for them.

I digress though. Assuming you are an average property investor and are considering re-financing in these opportunistic times, here is a list of things to think about when refinancing, to not only secure the best possible deal, but to maximise your interest-paying efficiencies throughout the property holding period. 

1) Be conscious of the 'real cost' of attractive ‘honeymoon’ style loan products when switching

Honeymoon loans are products that will offer heavily reduced interest rates for the first year or two, sometimes significantly lower than even the best standard rates in the marketplace at any time, and are very appealing for that reason. But you must investigate what then happens in say year #3 and beyond, when you take up such a product. For instance, what does your rate revert to, at that time? Oftentimes these offers from lenders are to attract new customers in, however the true cost of these products is not nearly as heavily promoted during the marketing campaign. Run the sums and calculate if this is actually a better product over say a 20 year holding period than say the most attractive standard deal on offer from another lender. Most of the time, standard mortgage products fare better in the medium-to-long term. 

2) Lender fees for breaking your existing mortgage (aka ‘break fees’)

Once you’ve found a loan product that you are convinced will save you money on your interest repayments during the short, medium, or long term (or even one that saves money from day #1 onwards), you must consider the additional fees and charges to break your current mortgage. Up until a few years ago this was a nightmare, with some lenders charging their customers exorbitant exit costs should they break a contract. However, there is great news here: in recent years, the federal government has introduced new strict guidelines that all lenders must abide by, to ensure customers can exit mortgage products without paying severe penalties to that lender for doing so.

Whilst the legislation assures much saving, it is still very critical that you check what the exit fees on your current loan(s) actually are, before committing to a new lender's products, as there are loopholes within the legislation that lenders have identified and capitalised fee structures around. For example, one of my mortgage products is less than one year old. Many lenders will have severe fees for those who break their mortgage in say the first twelve months. Fortunately for me, this particular lender only charged $95 to break this mortgage though other lenders can have fees in the thousands of dollars for breaking a contract within the first year. Such fees can make a plan to refinance to save money, redundant in the first place! 

3) Changes to the value of loan credit you are seeking creating additional expenses

When refinancing, the new lender will need to approve you just as your previous lender did. Just because you were approved for lender X, several years ago, does not mean lender Y will not do their homework on you! New lenders will always demand a valuation of the property be conducted, and good lenders worth their salt will have an independent valuer dispatched at your expense – and not just use their own internal valuer and no (aka ‘free to you’) expense. This is a good thing – you should consider the independent valuation and investment and here is why: It is smarter for you to pay a small $100 (or so) valuation fee (tax deductible, mind you) and get a 'true' appraisal of your property value, rather than the new lender using their an internal bank-employed valuer, who will almost always provide a more conservative/lower end value which is worse for you. Variances could be in the tens of thousands of dollars, so if you were looking to refinance to extend your mortgage further, this valuation could make all the difference, so be sure to request from your new lender that an independent valuer be appointed at your cost.

4) Loan-to-value changes potentially causing Lender’s Mortgage Insurance to be paid

As mentioned above, if you are looking to increase the amount of the mortgage when refinancing, that valuer’s final figure is all the more critical. Why? A favourable valuation even $5K higher than a conservative one could be that 'make or break' difference between paying lenders mortgage insurance (aka LMI, which is arguably my biggest pet hate in all of property investment finance!), or not paying it. As a general rule/recommendation, I would argue that almost any refinancing plan where LMI becomes payable as a result of refinancing, is a bad refinancing plan, and you should be hitting the abort button and staying put in your mortgage product for another year or so.

5) Non-lender based transfer of title fees should be considered

Nominal as they may be, you are best to explore these as they may vary from state to state, as they must be tallied in with everything else when you are forecasting your profitability spread sheet prior to refinancing. If you are refinancing say an entire portfolio of ten properties, you can imagine these nominal costs adding up! Usually the state will charge paperwork (administration/stamping duty) fees for exiting one mortgage and transferring the title to the new lender. The good news is that most of this is a tax deductible expense. Part of the reason I am refinancing now, right near the end of financial year, is to make an early claim for these expenses as quickly as possible, to enable my case flow to increase faster, and get me expanding my portfolio with the next property purchase, quicker too.

6) New lender establishment fees and ongoing charges

Last of all you have the setup/establishment fees for the new lender. These can vary from lender to lender but my recommendation is this, the more established an investor you are, and the more properties you may be transferring to one lender (I.e. bringing more 'new business' to the new lender), the more negotiating power you have up your sleeve to get these initial costs such as application fees, waived or reduced. Maybe you can get some waived? Remember, in life of you don't ask, you don't get, so it never hurts to ask! Also remember that as you grow in your life as a property investor, you’ll eventually become a highly desirable customer to any lender, so use this leverage. Even as a first time investor who is refinancing your first property, do not be afraid to talk yourself up during this process. Mention that you are a professional investor who is looking to ‘grow’ with a strategic lender partner, as you expand your portfolio over the years. This is usually music to a lender rep’s ears, and they will regard you very highly as a result.

And negotiation should not end there. Some lenders may consider you a 'high value customer' if you have loans totalling over a particular dollar value, use this as negotiating power to maximise the rate deal you are offered. Consider both the establishment fees and ongoing fee schedule into your forecasting spread sheet to realise whether it is worth your while to switch lenders or not

Once you have tallied up all the lender and government costs to refinance in your spread sheets, simply run two scenarios:

1) The first one assumes you are switching and you should calculate say the first three years of that mortgage product.

2) The second one assumes you stay in your current mortgage product for the same term (another three years) for example. Though your rate might be higher, you could be better off staying put for three years if this figure overall is lower than the Sanrio #1's figure. Admittedly this scenario forecast is a lot harder to conduct if you are in a variable rate product and are switching to a mostly-fixed product.

Stay tuned for Part #2 where I will mention some refinancing tactics to consider and illustrate these with some examples.