Here Are 9 Things You NEED to Know About Refinancing Mortgage Loans [UPDATED]
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 you’d want to consider refinancing include a drop in interest rates, a shorter loan tenure or the option to use your home equity (the difference between the market value of the property and the outstanding mortgage balance) to cover large expenditures.
Explaining Home Loan Refinancing
Home loan refinance means the process of swapping out loans, and moving your debt to a different loan with a lower interest rate.
Here’s how refinancing works:
Due to these developments, you want to refinance your home loan. You could apply for up to 80% 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.
However, be aware that if you borrow more than your current outstanding balance, you will increase the principal amount owed to the bank. This means more interest incurred over the tenure of your loan.
If you opt to apply for the exact amount to cover your current outstanding loan balance (in our case S$200,000), 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 does makes sense to consider refinancing your home loan every time the interest rates drop.
|Before Refinancing||After Refinancing|
|Tenure||30 years||30 years|
|Total interest incurred||S$84,487.05||S$39,941.21|
From the comparison above, you can see how the difference of 1% affects the monthly repayment. It also makes a huge difference in the total interest incurred over the loan tenure. You could save about S$44,545.84 with the lower interest. But what are the other things that need to be taken into account before you make that decision?
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.
The legal fees alone can cost from S$2,000 to S$3,000. On top of that, if you decide to refinance before your lock-in period is up, you need to pay a penalty fee that amounting up to 1.5% of your outstanding loan.
Referring to the example above, the difference in monthly repayment is S$123.50 every month if you refinance your home loan. If you are paying legal fees of S$3,000 excluding the penalty fee, it will take about 24 months (S$3,000 / S$123.50) before you enjoy real savings on your outstanding loan.
On top of that, you need to consider what’s the benchmark of your interest rates are pegged to. Usually the loans are tied to three different benchmarks, such as:
- SIBOR (Singapore Interbank Offer Rate)
- SOR (Swap Offer Rate)
- Bank’s own Internal Board Rate
- Fixed Deposit-linked home loans
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.
The benefits of refinancing?
Refinancing can be time-consuming and expensive. However, there are several potential benefits of refinancing.
#1 You can save money on lower rate of interest
One of the most popular reasons to refinance is to cut down on interest costs. Generally, it means that lender refinance into a new loan with a lower interest rate compared to existing interest rate.
In terms of long-term benefits, lowering the interest rate can result in significant amount of savings. Saving 0.1% to 0.5% on interest rate can be an incentive enough for refinancing.
Let me give you an example, imagine you have a mortgage of 30 years with the principal amount of S$1,000,000:
|S$1,000,000 with interest rate of 1.88%||Monthly repayment: S$3,636|
|S$1,000,000 with interest rate of 1.55%||Monthly repayment: S$3,475|
#2 Boost one’s cashflow
Not only can you save huge amount of money, refinance can lead to lower monthly repayments as compared to existing monthly mortgage payment.
This will improve cash flow management, leaving you with more discretionary income for other expenses.
For instance, you can choose to extend loan tenure for the loan, which means a lower monthly payment, coupled with lower interest rates.
#3 Change your loan type
Refinancing sometimes will not get you a lower interest rate or monthly repayment. However, some home owners choose to refinance to convert their fixed rate mortgages to variable rate mortgages.
Variable rate mortgages generally offer rates of interest that are lower than the fixed rate mortgages. Yet, there are times where the rates of interest offered by variable rate mortgages can reach a point that it is higher than the fixed rate mortgage interest.
When this happens, shifting to a fixed rate plan can essentially help you to benefit from the lower rates of interest. This will also eliminate all other possibilities of hikes in interest rates in the future.
A floating rate package has a rate of 0.7% + 3M SIBOR. Here’s the difference in interest rates if SIBOR rate increases:
|A||0.7% + 0.8% = 1.5%|
|B||0.7% + 1% = 1.7%|
On the other hand, a fixed rate package is not pegged to SIBOR. If the rate is 1.5%, it will remain 1.5% for the duration of the fixed rate period, regardless of how SIBOR fluctuates.
Who should consider mortgage refinancing?
#1 People on the 4th year of their loan package, who are not under a lock-in
On the fourth year of the loan package, the interest rates will rise. This is the best time to refinance if your loan package has no lock-in clause.
The lock in period is valid for 1 to 3 years typically. If you try to refinance during the clause, you will need to pay a penalty of typically 1.5% of the loan quantum.
For instance, if you have a loan of S$1,000,000, you will need to pay S$15,000 in penalty. If refinancing is still your best option, speak to a mortgage broker to understand the pros and cons specific to your situation.
#2 Investors that plan to sell in the short term
If you’re planning to sell the property in the next five to seven years, you don’t need to be overly concerned with the 4th year rates. What you can do is to look for a home loan package that comes with the lowest rates for the first three years and actively look into a cheaper package on the fourth year.
With refinancing, you’re planning to take advantage of lower interest rates to lower your monthly repayment. By switching to a package that offers a lower interest rate, you can potentially cover your instalment with your monthly rental, or even pocket the difference.
#3 Home owners who need cash
If you refinance your home loan after your property has increase considerably, then you can choose to cash out your home equity. However, it’s only for private properties such as condominiums and landed houses. Not for HDB flats.
What it means is that you’re refinancing your mortgage for more than you’re currently owe. You can take out the difference in cash.
For instance, you bought your house a few years ago and have been paying the loan. Over the years, the property’s value has increase.
Now you owe S$300,000 on a house that’s worth S$1.6 million. You have recently looked up mortgage rates and have discovered that you can find a lower rate if you refinance.
In this situation, you can refinance for more than the S$300,000 you currently owe. If you need S$500,000 cash, you could refinance for $800,000.
You would now owe S$800,000 on your mortgage where you cash out S$500,000 in cash, and the balance S$300,000 is used to repay your old loan.
However, the refinancing process would be the same as applying for a home loan where you need to prove your ability to service the loan by providing the usual documentation of income, assets and debts.
Tips on refinancing your home loan
#1 Monitor the lock-in period
We’ve to bear higher payment for a minimum of next three months due to the notice period requirement. If you monitor your lock-in period, you will be able to make the decision to refinance and start the application process earlier.
Best time to refinance is to do it four to seven months ahead of the lock-in expiry.
#2 Switch banks for a better offer
What we would suggest is to call their bank to further negotiate for the best refinancing offer, but of course, you need to do your homework first by looking elsewhere for a better deal and counter the offer.
#3 Improve your TDSR
The Total Debt Servicing Ratio (TDSR) is a framework to ensure that people borrow and banks lend, responsibly.
Basically, what it means is that TDSR limits the amount borrowers can spend on debt repayments to 60% of their gross monthly income.
It was introduced to ensure loans are only issued to individuals who can actually afford them.
“Dressing up” your TDSR is essential by clearing up some of your other debts and it’s advisable to perform it a month or two ahead so that it’s showing fully paid on your Credit Bureau report.
You can get your credit report from the Credit Bureau website.
To wrap things up, home loan refinancing needs to be considered carefully before making a decision.
Refinancing can have a positive impact on your pocket if it lowers the payments for your mortgage, decreases the tenure of your loan or boost your home equity. You can also manage your debt when you use this this tool carefully.
Before you decide to refinance, it is important that you understand your current financial situation and ask yourself whether it’s worth it.
On a side note, if you’re still unclear if you should refinance, crunch the numbers to see if it makes sense for you by utilising our home loan calculator to get the best home loan rates in Singapore!
First published on July 22, 2013.