Refinancing your home to get a new car? Ask these questions first.
On paper, refinancing your home to pay for a new car can sound like a good idea.
Depending on your situation, refinancing can be an easier or more affordable way to purchase a new vehicle. It can also mean simpler repayments as your car and home loans are essentially rolled into one.
In practice though, refinancing your home to pay for a new car can be significantly more complicated. It can mean additional fees and charges, as well as more interest to be paid overall.
Here are five questions you should ask yourself before refinancing your home to pay for a new car.
1. Do I have enough equity in my home?
Refinancing could reduce the equity in your home.
If you're just starting out with your home loan, you probably won't have a lot of equity.
Refinancing to take on additional debt will lower your equity further. If your equity drops below a certain threshold, you could be looking at significant charges in the form of Lenders Mortgage Insurance (LMI).
LMI typically applies when a lender borrows more than 80% of the total amount. So for example, to avoid LMI on a $500k mortgage, you would need a deposit of at least $100k.
While initially you may have avoided LMI by paying a 20% deposit, refinancing for a new car could push you back past the LMI threshold.
To continue our example of a $500k mortgage, say you've paid your $100k deposit, plus another $20k in repayments. If you were to take out an additional $40k for a car loan, the equity in your home would no longer amount to more than 20%.
| Amount (sum) | Total (%) | Above LMI Threshold? | |
|---|---|---|---|
|
Home equity |
$120,000 |
24% |
Yes |
|
Home equity – car costs ($40k) |
$80,000 |
16% |
No |
As you can see in the table above, if you were to refinance with this amount of equity, you would likely be required to pay Lenders Mortgage Insurance.
"On paper, refinancing your home to pay for a new car can sound like a good idea."
2. Will I pay more in interest in the long run?
Before refinancing, it pays to crunch the numbers.
Adding the cost of your car to your home loan can seem like an attractive proposition.
Home loan interest rates, due to the size of the asset, are generally lower than car interest rates. Therefore, based purely on interest rate figures, it can look like you're paying less by refinancing.
However, when you refinance to add the cost of your car to your home loan you are essentially combining two loans.
Once combined, the two loans will become indistinguishable from one another.
What does this mean for your interest?
It means you will be paying interest on the price of your car for the remainder of your home loan term. With a typical home loan term, this could be between 25 and 30 years.
Conversely, an average secured car loan is designed to repaid in 3 to 5 years.
Before refinancing it pays to crunch the numbers. While you may be able to get a cheaper interest rate by refinancing, you may end up paying much more overall, because of the substantially longer repayment period.
3. Will refinancing fees mean I pay more overall?
Refinancing your home is not free; lenders will charge you fees to do so.
The exact cost of refinancing will depend on your credit score, your mortgage lender, and the amount of your mortgage. You may also have to pay for a home appraisal and possibly a home inspection.
Here is a breakdown of the fees you will likely pay when you refinance.
| Expense type | Cost* |
|---|---|
|
Loan exit costs |
|
|
Discharge fees |
$100–$200 |
|
Government charges |
|
|
Mortgage deregistration fee |
$120 (price differs by state and territory) |
|
Mortgage registration fees |
$120 (price differs by state and territory) |
|
New loan costs |
|
|
Application fee |
$500 |
|
Settlement fee |
$75 |
|
Bank valuation fee |
$220 |
|
Legal and admin costs |
|
|
Title search fee |
$30 |
|
Preparation of mortgage documents |
$100 |
|
Total refinancing costs |
$1265–$1365 |
Source: finder.com.au
*This list is not exhaustive, additional costs may also apply.
"Refinancing your home is not free; lenders will charge you fees to do so."
4. Am I opening myself up to more debt?
Mazda 6 – Image courtesy of caradvice.com.au
Combining loans can make your debt simpler. It can also make debt easier to accumulate.
Once the cost of your new car has been added to your home loan, it can be easy to dismiss the debt as just another part of your home loan, which strictly speaking, it is.
While you won't 'forget' about this debt, it is a lot easier to put it out of mind. Because of this, it may be tempting to take on extra debt, via credit cards or an additional loan such as a boat or caravan loan.
It is, therefore, important to remember, that while it may not seem like you have taken on additional debt, in real dollar terms, you certainly have. Think of this when considering your next credit purchase.
5. How does refinancing compare to a secured car loan?
At Rapid Finance, we've helped our clients to refinance their homes to get a new car. We've also helped clients to get secured car loans. And, in our experience, secured car loans are often a more suitable option.
There is, of course, no blanket rule. Which option is right for you will depend on your circumstances and your loan needs. In any case, it is always worth considering a secured car loan as an alternative solution.
Why a secured car loan may be a better choice
- Security: With a secured new car loan your new car is generally taken as security on that loan. So, should you default on the loan your new car will be taken as security.
Conversely, if you refinance and add the car's value to your home loan, then your home is usually the security. So, should you default, your lender could potentially repossess your home. - Cost: Home loan interest rates are generally lower than secured car loan interest rates. However, as stated above, home loan terms are usually much lengthier.
When choosing between refinancing and a secured car loan, include all fees and charges. You may be surprised by which is cheaper in the long term. - Time: A secured car loan typically has a term of just 3 to 5 years. An average home loan, on the other hand, has a much longer loan term, usually 25 to 30 years.
A secured car loan's shorter loan term means higher monthly repayments. It also means that you will most likely pay off your new car debt sooner.
Summary
Refinancing the family home to pay for a new car is, for many people, a viable option.
It may be the right choice for you, given your circumstances and loan needs. Still, this finance solution does have its drawbacks. So, it is a good idea to examine all factors and alternatives.
Searching for more information on car finance solutions?
Visit our refinancing page or our car loans page.