Mortgage Refinancing – Who it is for and why you should do it
Interest rates have been rising gradually over the past 18 months and there are both benefits and difficulties at the same time. Those who have savings in fixed deposits will notice that they are earning more interest with the rise in interest rates. On the other hand, those who have outstanding loans from banks, such as car loans or mortgage loans, will have to pay more in loan repayments due to an increase in loan interest rates. Recently, there are a few clients who raised concerns about having to pay more for their loan installments and how it will affect their financial plans. One of the most common questions we received is that of mortgage refinancing.
Most mortgage loan repayments take up about 30 – 50% of a home-owner’s monthly income, and it is easily the biggest purchase in your lifetime.
While some home-owners are happy to have chosen a home loan and repay the monthly instalments regularly until the end of their mortgage term, what they neglect is that the interest rate environment has changed and you could be over-paying for your home loan now. This is when mortgage refinancing can give you some serious savings.
What Is Mortgage Refinancing?
Mortgage refinancing occurs when you switch from one loan package to another. This is done in order to take advantage of cheaper home loans available, thus reducing the cost of borrowing. Sometimes, you may also find a better loan from the existing bank you use, so you can request for a switch of loans within the bank. This is call repricing instead of refinancing.
The main difference between refinancing and repricing is that the latter might be cheaper as you save on the legal fees to handle the paperwork for the transfer of the loan to a different bank.
Why Should I Refinance my Mortgage Loan?
1. Most home loan packages are structured such that interest rates are low in the first 2 to 3 years and will be adjusted significantly higher from the 4th year onwards.
Hence, it is important for home owners to look into refinancing after 2 or 3 yrs (depending on lock-in and claw back period) so that they do not end up paying a higher interest rate than the market rate.
2. Interest rates can change significantly within a short period of time, and borrowers can take advantage of cheaper loan rates by refinancing.
For instance, the Singapore Interbank Offered Rate (SIBOR) has increased nearly 2 folds since Dec 2014.
Take for instance a borrower, Alan, who took up a mortgage loan in 2015 to finance his condominium purchase. At that time, Alan decided that a fixed rate loan of 1.5% was suitable for him, since he prefers to know exactly how much he needs to pay per month. After 2 years, the interest rate environment has changed, as shown by the SIBOR rates provided below:
Click image to enlarge
Source: The Association of Banks in Singapore
Now that his 2-year lock-in period is over, Alan is open to taking up a variable rate loan that can offer him more savings. He can now find a loan that offers him a rate as low as 1.38%, which can potentially help him save about $1,650 in the next 3 years.
As the SIBOR is influenced by US interest rates, we can expect local rates to increase further in 2017 due to rate hike in the US. This is why it is important for borrowers to seek out alternative loan packages to protect themselves against an increase in interest rates.
3. Price wars among the banks here are usually good news for borrowers, since this will keep the interest rate low and competitive.
Banks sometimes introduce new innovative mortgage loan products that work to borrowers’ advantage.
For instance, in the last few years, we’ve seen a new type of mortgage loan that pegs to the bank’s fixed deposit rate. Since it is in the bank’s interest to keep the fixed deposit rate low as it is a cost to the bank, some borrowers feel that it can provide a good alternative to a SIBOR-pegged loan.
What Are The Things To Take Note Before You Consider Refinancing?
It is not a guarantee that refinancing your home loan will always help you save up a sizable amount of money. There are some factors you need to consider before you refinance, as there can be situations where you are better off sticking to your current home loan package.
- Lock-in period and penalty – full redemption during the lock-in period of your current loan will cost you a penalty of about 1.5% of your loan value. This is a significant amount – $9,000 based on a loan amount of $600,000. The lock- in period commonly range from 1 to 3 years, while some packages set you at a 5-year lock-in. The borrower needs to include this as a cost to ensure the potential interest savings outweigh all costs involved.
- Claw back period – many banks dole out a generous amount of subsidies in order to attract clients to take up their home loans. These subsidies come in the form of free fire insurance, and/or waiver of legal and valuation fees. If you decide to refinance, some banks may claw back on these benefits or impose a minimum period where you’ll need to stick with the loan in order not to incur penalties.
- Notice period – you need to serve 3 months’ notice to your existing bank if you want to refinance to another bank. So timing your refinancing is important if you do not wish to pay a higher interest in the following year. It is advised that borrowers start their refinancing research early and give enough notice to their current bank.
As much as possible, consider taking a proactive approach towards managing your mortgage loan since the interest payments may add up to sizable amounts. This is especially important if you are not looking to sell your homes in the short term as refinancing can allow you to enjoy interest savings and put aside the amount for investments or other income-building usage.
Remember, managing your mortgage loan is part of a bigger picture which is your overall financial plan. If you are not confident, work with a financial planner to take the first step of getting the budget right before you explore how to outmaneuver the interest rates trends.
Good luck and may you get your sums right!
Article by Marcus Lee