Refinancing Your Home Loan – How Does It Work?
A lot of people decide to refinance their home loan sometimes during the payback period. But what exactly is home loan refinancing? It simply means taking out a new home loan in order to repay the old one. The main reasons why people decide to use refinancing are quite obvious, and include a drop in interest rates, shortening the loan tenure or using their home equity (the difference between the market value of the property and the outstanding mortgage balance) to cover large expenditures (e.g. home renovation).
Explaining Home Loan Refinancing
The best way to explain how home loan refinancing works is by using an example:
Let’s say you took out a mortgage of S$500,000 at 2% to finance a property worth S$650,000. After a certain period of time, your outstanding loan balance is S$300,000, the interest rates drop to 1%, and your home value appreciates to S$750,000.
Due to these developments you want to refinance your home loan. You could apply for up to 90% of the current market value of your home, depending on the bank policy. That sums up to roughly S$675,000, which is more than your outstanding loan balance. If you apply for the maximum amount, or any amount larger than your outstanding home loan balance, the excess money could be used for expenditures such as home renovations, debt consolidation or other things that require a big cash outflow. Be aware that if you borrow more than your current outstanding balance, you will increase the principal amount owed to the bank.
In case you opt to apply for the exact amount to cover your current outstanding loan balance (in our case S$300,000), you will simply repay the old loan with the new one, with no additional cash borrowed. This can result in lower monthly payments or shortened loan tenure with the same monthly payments. At a glance it thus makes sense to consider refinancing your home loan every time the interest rates drop. But what are the other things that need to be taken into account before deciding?
Costs to be Aware of When Considering Home Loan Refinancing
It is important to be aware that the interests rate you pay are not the only cost associated with a loan. Application costs, administration costs, processing fees, valuation and legal fees can be quite substantial, amounting up to S$6000 and more, depending on your loan amount. If refinancing does not justify these fees in a reasonable amount of time, it might not be the best choice. Another thing worth noting – including these fees in the loan amount will increase the principal you owe to the bank, thus increasing the loan term or the monthly payments.
Another thing you need to consider is what benchmark your interest rates are pegged to. In Singapore, the loans are tied to three different benchmarks, namely SIBOR (Singapore Interbank Offer Rate), SOR (Swap Offer Rate) and the bank’s own Internal Board Rate. While SIBOR and SOR provide a more transparent view of how interest rates are structured, the Internal Board Rates have proven to be more stable and consistent over time. This is not to say that you should always go for a home loan refinancing that is pegged to the Internal Board Rates, but rather to make you aware of characteristics of different benchmarks – what might be a good choice for person A might not be the best for person B.
To wrap things up, home loan refinancing needs to be considered carefully before making a decision. If it can save you money after acknowledging all the costs involved, then by all means go for it. iMoney.sg can provide you with a comparison of various mortgage packages on offer in Singapore. If, on the other hand home lone refinancing turns out not to be as attractive as it was at first sight, you may want to skip it or wait for the interest rates to drop further.