Real Estate Institute advice on refinancing homes

Press, 1 March 1989, Page 57

Real Estate Institute advice on refinancing homes

The best loan options for homeowners depends totally on individual circumstances, according to Mr Dennis Waller, of Kendall Waller Corporation Limited, merchant bankers, Auckland.

Approached by the R.E.I.N.Z. for comment on what up-to-date advice real estate agents could give to homeowners interested in refinancing, Kendall Waller provided the following information: Homeowners normally perceive that interest rates are lower than they really are, and that interest rates will come down faster than they really will. In this situation, a floating rate is preferable. The media has, of late, focused on whether it is better to have a principal and interest, or an interest only loan. As a generalisation, a 15-year principal and interest loan would not entail very much higher repayments than an interest only loan.

For example, a loan of $lOO,OOO at 17 per cent over 15 years works out at $1517.51 per month versus an interest only repayment of $1416.67. If someone is looking to buy, renovate and sell and. move to another house, the lower repayment option offered through an interest only loan would be better. If there were two incomes and the house owners were young, it would be in their interest to repay as much of the principal as possible in case something happened to the double income.

One of the advantages of an interest only mortgage is that the loan is taken out in today’s dollars and repaid in future dollars. If inflation continues to take its toll at, say, 10 per cent p.a., then $lOO,OOO in 10 years will be worth the equivalent of less than $40,000 today. Even an inflation rate of 5 per cent gives a present value of only $60,000. In either case these amounts are more easily paid back.

There are no short answers in deciding the best loan option. The situation of each borrower needs to be fully assessed.

Those borrowers asking the question — “to refinance or not to refinance?” will be aware that the consistent, though somewhat erratic, downward trend in interest rates has created a completely new borrowing environment with a wide range of options.

Borrowers with a substantial portion of their loan terms still to run must decide whether it is economically viable to break the term and refinance, or continue in the hope their lender will consistently reduce their interest in accordance with market trends.

In a falling interest rate environment, some form of penalty interest is possible. This is particularly so with fixed term loans sourced from mortgage bonds and the like. Penalties could add

substantially to the cost of refinancing.

Following is a typical residential finance package arranged over the last two or three years. It gives an indication of what a borrower could expect to encounter when refinancing:

Existing loan details Example Loan $lOO,OOO Term 5 years interest only Term Expires 2 years Rate at beginning 19.5 per cent variable

Current rate 18 per cent variable

Monthly payment 18 per cent variable

Penalty for early repayment 1 month’s interest New loan

Penalty for early repayment $l5OO

Lender’s fee (1 per cent) on new loan $lO4O

Legal and other fees (approx. 2 per cent) $2OOO Cost of refinance (total of above) $4540 Amount of old loan $lOO,OOO Amount of new loan $104,540 New term 5 years interest only rate 16.5 per cent variable Monthly payments $1437.43

Savings per month $62.58 Cost of achieving this based on above $4500

From that example, there is little advantage to be gained from refinancing unless the present lender is unlikely to reduce its rates in the near future, or on any form of regular basis thereafter.

The key question to ask about refinancing is how quickly will existing loan interest rates reach those available on new loans? As this situation has never existed before in New Zealand, there are no previous experiences to draw upon. The borrower, therefore, must rely heavily on the lender’s past record, and the composition of the funding sources from which the loan funds are derived.

If refinancing is being considered for other reasons, as well as lower interest rates, the given calculations are of less importance but still should be considered. Structured loans now available in a number of different forms can achieve not only a lower cost of borrowing, but can substantially reduce cash payment requirements. Dismissing the possibility of refinancing based upon interest rate reduction alone could be rather unwise. A change to a more flexible package, which offers regular predetermined rate reviews, may be expensive at the outset but prove cheaper over a longer term. Open ended loans offering credit line-type facilities could be invaluable to small businesses, or individuals, wishing to expand, or improve their home or commercial premises without the need for further arrangement costs.