Life is like a box of chocolates: it has an expiry date. And yet, a large part of our limited time is wasted on paying off our home loan. And on raising children so that some day, they can pay off their home loan, and we can sit around saying things like “Now then you know”. But this dark cycle has got an escape clause: clever refinancing.
What is Refinancing?
Refinancing is the process of changing your home loan terms. It’s done for a number of reasons, but the main ones are:
- To pay off the loan faster – By refinancing, you can find a bank with a lower interest rate. This ultimately translates to paying off the loan faster.
- To get a term loan – You can do cash-out refinancing, to get a bank loan at low interest. This is complicated, so it’s discussed in more detail below.
- To lower monthly payments – If you need more spending money, refinancing can lower your monthly repayments.
- To respond to changing market rates – If SIBOR and SOR are climbing like a monkey with its butt on fire, now may be a good time to switch to fixed rates.
- Dissatisfaction with banking protocols – Maybe even CERN physicists couldn’t figure out the math your bank is using. Or their “help desk” ought to be reclassified as “word game”. Time to switch banks!
Switching to Fixed or Floating Rates
The interest on your housing loan is determined by the Singapore Inter-Bank Offer Rate (SIBOR) or international Swap Offer Rate (SOR).
When the economic situation is good, SIBOR and SOR tend to rise. You’ll want to get a fixed rate asap; this will prevent your monthly repayments from climbing with the market.
On the other hand, SIBOR and SOR decline when the markets are in recession. Then you’re better off with a floating rate, which will decline with the market.
To gain a better understanding on rate types, see our article on fixed and floating rates.
Getting a Term Loan
Barring improbable events (condemned buildings, flooding problems, etc.), property will usually go up in value. The house that you bought for $300,000 may be worth double that in 10 years. This gives you an opportunity to take out a term loan, also known as cash-out refinancing.
The bank takes the current market value (CMV) of your house, and deducts the amount you’ve already paid. The difference is the amount you can borrow. So if your house has a CMV of $300,000, and you’ve paid back $10,000, your can get a term loan of ($300,000 – $10,000 = $290,000).*
The advantage of a term loan is the interest rate, which matches your home loan rate. This is the lowest interest you can get for a bank loan.
* If you used your CPF in paying for your house, you must pay back the amount you used when you get a term loan.
Refinancing for Better Rates
When you shop around for a home loan, you can compare offers from different banks. You may end up with a choice like this:
|1st Year Interest||2nd Year Interest||3rd Year Interest||4th Year Interest||5th Year Interest|
|Bank X||0.2 %||0.4%||0.8%||1.0%||1.5%|
|Bank Y||0.6 %||0.6%||0.6%||0.6%||0.6%|
Based on the table, you can see Bank X has a lower interest rate for the first two years, and a higher rate for the 3rd, 4th, and 5th year.
In this case, you’d take the loan from Bank X, at least for the first two years. After that you’d refinance, switching to Bank Y. In another few years, you might check to see if better rates exist, and refinance accordingly. With some simple fact checking, you can keep to the lowest rates until you finish the repayments.
When you take out a housing loan, some banks may issue a lock-in period.
During the lock-in (usually one to three years), you cannot refinance without a paying a penalty. In most cases, this is a stroke-inducing 1.5 percent of the total loan.
So if you intend to refinance, look for loan packages with no lock-in period. But if you don’t intend to refinance, look for loans with extended lock-in periods. They’re usually cheaper, and the disadvantage is irrelevant to you.
Right of Clawback
Apart from the lock-in period, beware the right of clawback.
When you buy a house, there are legal and insurance fees. These are usually paid for by the bank. If you refinance, the bank has a right to claim those subsidies back from you. In Singapore, clawback might range from $2500 to $3000.
The right of clawback may extend beyond the lock-in period; it’s possible to have a one year lock-in with three years right of clawback. Most buyers are willing to suffer clawback, since the amount they’d save from refinancing more than makes up for it. Still, it’s best to know exactly when the right of clawback ends; it might be worth waiting a few months for it to expire.
Repricing means refinancing without changing your bank. This usually happens when you spot a better interest rate, but it’s coming from the same bank you’re already paying money to.
Most banks offer a one-time repricing option, where you can switch loan packages at no cost. Beyond that, there is usually an administrative charge of $500 – $800 to reprice your loan. Note that the lock-in period still applies; if you reprice your loan within the lock-in, you still bear the penalty.
Good Signs for Refinancing
In general, the best signs that you should refinance are when you meet the majority of these conditions:
- There is a loan package with a better interest rate
- You are on a floating rate, while SIBOR and SOR are on the rise
- You are on a fixed rate, while SIBOR and SOR are declining
- You have passed the lock-in period, or have no lock-in
- The bank no longer has right of clawback
- You have not exercised your one-off option to reprice your loan
Before refinancing, check that available loan packages are better than your existing one. If you find it time consuming to call the banks, compare the rates via websites like MoneySmart.
Just click “refinance”, enter the details of your property, and MoneySmart will retrieve the best refinancing options. Their mortgage specialists are also on hand, and can contact you to give advice on the most appropriate packages.
Are you intending to refinance? Tell us why in the comments!
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Tags: Home Loans