The monthly repayment is the wrong number to look at
Refinancing is sold on the repayment, because the repayment is the number that always improves. Drop the rate and it falls. Extend the term and it falls further. The trouble is that only one of those two levers actually saves you money, and the second one systematically costs you while appearing to help.
A borrower twenty-four years into a thirty-year loan who refinances onto a fresh thirty-year term has just added six years of payments to the back of the loan. The repayment falls immediately and visibly. The total interest can rise by tens of thousands, invisibly, because nobody ever presents that figure at the point of sale.
The two numbers that matter are the break-even point, which is how long the monthly saving takes to repay the switching costs, and the change in lifetime interest. Neither appears in a typical refinance pitch, and both are straightforward to compute.
Break-even, and why your time horizon decides it
Switching costs money: a discharge fee from the outgoing lender, an application or establishment fee from the new one, a valuation, and government registration charges. Together these typically run from several hundred to a few thousand. The monthly saving has to repay that before you are ahead of where you started.
Divide the net upfront cost by the monthly saving and you have the break-even in months. On a large balance with a meaningful rate drop this is often startlingly short, sometimes under six months. On a small balance with a marginal rate improvement it can run past five years, which for most borrowers is longer than they will keep the loan.
That is the real test. If you might sell the property, move, or refinance again before the break-even point arrives, the switch loses money regardless of how good the rate looks. Compare your honest time horizon against the break-even figure and the decision usually makes itself.
Ask for the term to match, then keep your old repayment
Lenders default to a thirty-year term because it produces the most attractive repayment. Almost all of them will write the loan to match your remaining term instead if you ask, and asking costs nothing. Doing so removes the term extension entirely, so the lower rate does what you actually wanted it to do.
Better still, refinance to the lower rate, accept whatever term is offered, and then set your direct debit to the repayment you were already paying. The difference goes straight to principal. Your budget does not change, because nothing in your budget changed, and the loan clears years earlier. On a typical refinance this is worth several times the headline monthly saving.
If your lender offers an offset account, parking the difference there achieves much the same effect while keeping the money accessible. Every dollar in the offset reduces the balance interest is charged on, and because that saving is effectively at your loan rate and free of tax, no savings account competes with it.
Cashback offers, honeymoon rates and break costs
Treat a large cashback with scepticism proportional to its size. It frequently accompanies a rate that reverts sharply after an introductory period, or an annual package fee that quietly exceeds the cashback within a few years. Model the rate you will be paying in year three rather than the rate advertised for year one, and include the fee change.
If you are on a fixed rate, check the break cost before doing anything else. Exiting a fixed loan early can incur an economic cost running to thousands of dollars, and it does not appear in any advertised comparison of switching fees. Ask your current lender for the figure in writing.
And before approaching anyone else, phone your existing lender's retention team and ask them to match the rate you have been offered. Keeping a loan is far cheaper for a bank than winning a new one, and they frequently match or come close. It takes an hour and costs nothing, and it captures most of the benefit with none of the fees or paperwork.
Questions people ask
- How much of a rate drop is worth switching for?
- There is no universal threshold, because it depends on your balance and the switching costs. On a large balance even a quarter of a per cent can break even within months; on a small balance a full percentage point may not. Run the break-even on your own numbers rather than trusting a rule of thumb.
- Why would a lower rate cost me more?
- Because refinancing usually resets the loan term. Moving from 24 years remaining onto a fresh 30 adds six years of payments, and the interest on those extra years can exceed everything the lower rate saves. Matching the new term to the time remaining avoids it completely.
- Should I capitalise the switching costs into the loan?
- It avoids finding the cash up front but you then pay interest on those fees for the life of the loan, which lengthens the break-even. If you can pay them from savings, do. If not, capitalising is still usually better than not switching at all when the rate gap is meaningful.
- Will refinancing hurt my credit file?
- A credit enquiry is recorded and has a modest, temporary effect. Repeatedly applying to several lenders in a short period has a larger effect than a single application, so shortlist first and apply once rather than shopping applications around.
Sources
- MoneySmart: Home loans. Australian guidance on switching loans, fees and comparison rates
- Consumer Financial Protection Bureau: Mortgages. US guidance on refinancing costs and closing disclosures
- MoneyHelper: Homes. UK guidance on remortgaging and early repayment charges