Is Refinancing Worth It? How to Weigh the Maths

Is refinancing worth it? In most cases it comes down to one question: do the savings from a lower interest rate beat the costs of switching, and how long does that take to happen? Refinancing means moving your home loan to a new loan, either with your current lender or a different one, usually to get a lower rate or features that suit you better. Whether it pays off depends on your circumstances, your current rate, the fees involved, and how long you plan to keep the loan. This guide walks through the numbers so you can decide whether it is worth refinancing for your situation.

This is general information only. The work here draws on the Australian Securities and Investments Commission’s MoneySmart service, the government’s independent money guidance.

What refinancing actually means

Refinancing is the process of replacing your existing home loan with a new one. You might do this to chase a lower rate, switch from a variable to a fixed rate, unlock features like an offset account, or consolidate debt. Our refinance home loans hub sets out how the process works from start to finish. According to MoneySmart’s guide to switching home loans, there can be a difference of more than 2% between variable home loan rates, so the loan you signed up for years ago may now sit well above what is available today.

Before you go anywhere, it is worth asking your current lender for a better deal first. Lenders sometimes match or beat a competitor rate to keep your business, and a phone call costs nothing. If they will not move, that is your signal to compare what else is out there.

Is it worth refinancing your home loan? Run the break-even test

The simplest way to answer “is it worth refinancing” is the refinancing break even calculation. You add up the one-off costs of switching, then divide that by the amount you would save each month. The result is the number of months it takes for the savings to cover the costs. If you plan to keep the loan well past that point, refinancing may be worth it. If you might sell or move again soon, it may not be.

A rate even 0.5% lower could save you thousands of dollars over the life of a loan, which is why a small gap is still worth checking against the switching costs. The maths is what matters, not the size of the rate cut on its own.

What the savings depend on

Your monthly saving is driven by three things: the size of your loan balance, the gap between your current rate and the new rate, and the loan term you choose. When you compare loans, look at the comparison rate rather than the headline rate. A comparison rate is a single figure that shows the cost of a loan as a percentage per year, including the interest rate and most fees, which makes it easier to compare loans on a like for like basis. You can read more in our comparison rate explained guide.

The costs that can erode the benefit

Switching is rarely free. The MoneySmart switching guide lists several costs that can apply when you refinance.

If you are on a fixed rate, leaving the loan early can trigger a break fee, which can be substantial and is set by the lender based on market conditions at the time. Break costs are the single biggest reason a refinance that looks good on paper may not stack up, so always ask your lender for a figure in writing before you commit.

Lenders mortgage insurance and your equity

Lenders mortgage insurance, or LMI, is a one-off cost a lender may charge when you borrow a larger share of the property value. If you have less than 20% equity in your home when you refinance, you may have to pay it again, even if you paid it on your original loan. That can be a deal breaker. It is worth checking your loan-to-value ratio first.

Our guides on how to avoid LMI and what is LVR explain how lenders work this out.

The loan-term trap

A lower rate does not automatically mean you pay less interest overall. If you stretch the loan back out to a fresh 25 or 30 year term, you can increase the total interest you pay over the life of the loan, even at a lower rate, because you are paying it off over a longer period. To keep the full benefit of a lower rate, you can ask the new lender to match your remaining term, or keep your repayments at the old level so the extra goes straight onto the principal. The choice depends on your circumstances and lender criteria.

When refinancing may be worth it

Refinancing tends to make sense when several of these are true:

• Your current rate sits well above the market and the gap is more than a small fraction of a percent.
• You have enough equity, ideally 20% or more, to avoid paying lenders mortgage insurance again.
• You plan to keep the loan past the break-even point.
• You are not locked into a fixed rate with a break fee that wipes out the savings.
• You want a feature your current loan does not offer, such as an offset account or the ability to make extra repayments.

The Reserve Bank of Australia, or RBA, Monetary Policy Board meets eight times a year to set the cash rate, which can move variable home loan rates. A rate that looked competitive last year may not be today, so it is worth reviewing your loan every year or two even if nothing has changed for you.

How to work out the numbers

You do not have to do this by hand. The MoneySmart switching guide recommends using a calculator to weigh the savings from a lower rate against the upfront costs of changing loans. Start by checking whether your current rate is still competitive, then test the gap against the switching costs.

Talk it through with the team at Finance Lab

Whether refinancing is worth it always comes down to your own numbers, your equity, and your plans for the property. If you would like a hand running the break-even maths and comparing what is available against your current loan, the team at Finance Lab can walk you through it. Outcomes depend on your circumstances and lender criteria.