Refinancing Fixed Or Interest-Only Loans: Is It Possible?

Anyone with a fixed or interest-only loan can refinance. In this post, we explain these types of loans and provide actionable advice on weighing your options when planning to refinance fixed or interest-only home loans.

What is a Fixed-Rate Home Loan?

In a fixed rate home loan, the interest rate is fixed for the duration of the specified term, which typically ranges from one and five years. However, the exact lock-in period depends on the lender.

When the fixed term ends, your loan will shift to the applicable standard variable rate in most cases. Alternatively, you can opt to refix your home loan. So, if your monthly mortgage repayments are $2,000, they will be the same throughout your loan term. This is why fixed home loans are popular, especially among first home buyers and investors.

In addition, budgeting for the other expenses is easier when you know the fixed element. Like any financial product, it’s a good idea to make informed decisions to reach financial goals faster.

What is an Interest-Only Loan?

On an interest-only home loan, you solely cover the interest component on the amount borrowed (principal) in your monthly repayments. For a specific period (for example, five years), you’ll not pay anything off the principal, so it doesn’t reduce.

Once the interest-only period ends, your loan will change to a principal and interest loan. Now, you’ll begin repaying the principal and interest repayments, which means higher repayments each month.

Why Would You Consider Refinancing?

The refinance amount you may be able to access depends on the difference between your property value (market rate) and your loan balance. Refinancing may work better for you in several ways, including:

1. Lower repayments and interest rates
2. You lender isn't supportive
3. Debt consolidation
4. Features and flexibility
5. Meeting your financial objectives
6. Second property purchase
7. Rising property prices

Below, we go further into depth about how these factors can influence your decision to refinance.

1. Lower Repayments and Interest Rates

It’s a highly competitive market with some lenders cutting rates and willing to offer fabulous deals. Refinancing may enable you to reduce your fixed rate interest repayment significantly.

Your Lender isn't Supportive

Sometimes, you may feel that the lender has not met your expectations. The gaps could be in communicating about the mortgage features, offering you a fair deal, or even routine customer support. In such as situation, refinancing may be a way to fix the glitches.

Debt Consolidation

You may consider rolling into one consolidated loan amount if you have more than one loan. Refinancing for debt consolidation can help you manage your repayments more efficiently - especially if the interest rate or ongoing fees are more competitive than earlier.

Features and Flexibility

A fixed-rate home loan usually does not have features like a redraw facility, offset account, and/or top-ups. Likewise, it does not allow you to make any extra repayments or benefit from future interest rate falls. So, refinancing to a variable loan may suit you due to greater flexibility if you’re looking to pay off your loan.

Meeting Your Financial Objectives

Your objectives may change and dramatically impact your financial status. For example, marriage, kids, divorce, relocation, new job, etc., are significant events where refinancing your fixed loan may help.

Refinancing to an interest-only home in particular loan frees up cash. This can help you temporarily manage your cash flow situation, especially if you’re in a non-salaried job, i.e., freelancer.

Second Property Purchase

Having built sufficient equity in your home, you may want to use it to buy an investment property. Refinancing helps you save money on loan repayments and lets you purchase your second house leveraging your equity.

Rising Property Prices

If your property value has increased substantially to a point where you now own at least 20% of the equity, you can refinance without paying Lender's Mortgage Insurance (LMI) and get a better rate.

Can You Refinance a Fixed Loan?

Yes, you can refinance your fixed-rate mortgage. However, refinancing a fixed rate home loan means you’re breaking a contract that you had signed agreeing on the loan period. Therefore, your lender will seek compensation for any loss.

This compensation typically requires you to pay a break and discharge fees, which can set you back by a few hundred dollars.

Just as lending criteria vary, lenders use their formula for calculating break costs. Generally, it’s based on the following key factors:

• The market interest rate at the time of fixing, compared to the present market interest rate.
• The time remaining on your fixed term.
• Your initial loan amount borrowed.

Typically, the more significant the drop in interest rates since taking out your fixed rate home loan, the more your break fee will be.

Can You Refinance an Interest-Only Loan?

Yes. You can refinance your interest-only home loan and shift to a loan with principal and interest repayments or an interest-only loan. The process is similar regardless of whether it’s interest only or principal and interest loans.

Illustrated below are two scenarios when looking at refinancing interest-only loans.

Refinancing From a Principal and Interest Loan to an Interest-Only Loan

You can refinance to an interest-only loan. However, interest-only loans are more suited to certain types of borrowers, such as property investors, primarily because of tax deduction benefits.

For example, you can deduct the interest paid on your investment loan from your tax bill if you’re an investor, something you can’t do as an owner occupier.

Refinancing to interest-only payments will reduce your loan repayments since you’ll only be paying the interest on your loan. However, in the long term, it’ll cost you more.

If you’re an owner-occupier, your chances of qualifying for a refinance to an interest-only home loan improve if:

• You own at least 20% of your property’s value. This may improve your chances of securing a lower interest rate during the interest-only period.
• Are financially capable of making principal and interest repayments when the interest-only period ends.
• You have a good credit history.

Refinancing from Interest-Only to a Principal and Interest Loan

Switching to a principal and interest loan is more common because of the following advantages:

• Faster ownership: As you start paying off both your principal and interest, you start building equity in your home faster and can pay off your debts quicker.
• More competitive loans: Interest-only loans come at higher interest rates and have fewer features, such as redraw and offset. Refinancing to a principal and interest loan helps you access more suitable deals and attractive loan features.

For more information on how to refinance, head to our comprehensive 8-step refinance process guide here.

What to Consider Before Refinancing Home Loan?

Sometimes, the cost of refinancing your home loan may outweigh the benefits. If you’re looking at refinancing, assess the benefits listed earlier in this article and evaluate them in the context of the following concerns :

1. Exit fees: Typically, you will have to pay break costs when refinancing a fixed-rate loan. Ask your credit representative about the break costs and compare this expense against the potential savings on refinancing.
2. Amount left to repay: If you don’t have much of your loan amount left to be repaid or if you’re looking to sell out within six months, refinancing could cancel out any financial savings.
3. Equity building: Refinancing to interest-only loans can delay ownership since you only pay the interest amount. If you want to clear your debts faster, avoid refinancing to an interest-only loan. Moreover, your repayment amount will be significantly higher once the interest-only period ends, placing additional stress on your monthly expenses.
4. Higher monthly repayments: You can expect an increase in your monthly repayments when leaving an interest-only loan. Assess your financial capability to make repayments before switching.
5. Lenders Mortgage Insurance (LMI): You cannot build equity on an interest-only loan since you aren’t paying off your mortgage principal. If you have begun with a small deposit, you may need to pay significant LMI again when refinancing. Therefore, refinancing is a better option for those with at least 20% equity in their property.

How Joust Can Help

The decision to refinance can be overwhelming. Our online marketplace can help you access suitable home loan products that can potentially save you thousands.