Despite what people still think, ostriches do not bury their hands in the sand at the sign of danger. They’re smarter than that. Yet, when it comes to money, many of us may think ignoring a problem is the same thing as avoiding it! Surprisingly, this happens a lot when it comes to home loans. Home loans take up the biggest part of most people’s budget, but we could be saving a lot of money if we just knew more about refinancing your home loan.
What is Refinancing?
If the interest rate on your home loan has shot up because you are past the 3rd year of your home loan, you are already losing money you don’t have to. Refinancing is the process of ending your existing loan package with your current bank by continuing your repayments with another bank that offers a better loan package.
Let’s say you currently have a SIBOR-based package that comes up to 2% per month from your existing bank. But another bank offers you a SIBOR-based package that totals 1.5% per month. By refinancing your loan with the bank offering a better loan package, you’ll be able to make lower monthly repayments.
Remember, there’s no such thing as a “loyalty” discount for staying with your current bank. If another bank offers a better loan package, it’s really in your best interest to refinance to save money.
Why Should I Refinance?
Say you bought your home about 3 years ago just before the property bubble burst. Your lock-in period of 3 years has just ended. For illustrative purposes, you may find the below calculations useful to find out how much you can save if you refinance now. Let’s say your current mortgage package is at 2% interest.
If your outstanding loan amount right now is $200,000, refinancing to a 1.5% mortgage package can potentially save you almost $5,000 in 5 years.
If your outstanding loan amount right now is $500,000, refinancing to a 1.5% mortgage package can potentially save you over $12,000 in 5 years.
If your outstanding loan amount right now is $1,000,000, refinancing to a 1.5% mortgage package can potentially save you over $24,000 in 5 years.
When to Refinance?
Most home loans have a lock-in period of 2-3 years. This means that if you refinance during this time, you will be slapped with a “cancellation fee” that usually makes the money you save from refinancing worth as much as an Eskimo’s refrigerator. Once you are free from your lock-in period, you should definitely shop around to see if there is a better interest rate available.
This is a crucial period because the low SIBOR rates that we’ve been enjoying for the past couple of years have already started increasing due to the recovering US economy.
What Kind of Refinancing Should You be Looking At?
1. Throughout rate package
For most mortgage packages, what the bank does is offer you a lower interest rate in the first two or three years in order to attract you to sign up with them. But what you may not realise is the increased interest rate in the fourth year and beyond. If you do notice it and point it out to them, they will simply say, “Don’t worry , you’ll be able to refinance it in three years.” When a bank tells you not to worry, that’s exactly when you should worry! The biggest concern is, in the future, you may not have the ability to refinance either due to a lack of suitable options or a lack of liquid funds. You’ll then be trapped by the bank’s higher interest rates, which is really what the bank is hoping for.
What we would suggest is getting a throughout rate package. In a throughout rate package, whether it’s the first year or the fifth year, the bank’s premium is fixed. For example, if the first year rate is 3month SIBOR + 1%, then in the fifth year, the interest rate will still be 3month SIBOR + 1%. Yes, in the first few years you will end up paying more, but with the throughout rate package, you’ll never need to worry about when to refinance.
2. Fixed rate home loan
Since the SIBOR rate has already started increasing quite dramatically, another suggestion would be to pick a fixed rate home loan. That is, an interest rate that does not depend on the SIBOR. Fixed rate packages maintain a static interest rate for a given length of time (typically 1 to 5 years depending on the package).
For these loans, the interest rates are pre-determined and “fixed” or “locked” at the time the borrower accepts the loan offer. For the entire duration of the fixed period, the agreed rate(s) will not change, regardless of market conditions.
It’s important to note that, after the given length of time, fixed rate packages automatically convert to floating rates. So you have to accept that the SIBOR is inevitable. You won’t be able to avoid it forever.
3. Fixed Deposit-Linked Home Rate
A third possibility, especially in this current rising interest rate environment is to consider home loan packages that are linked to a bank’s fixed deposit rate. This is a relatively new mortgage package offered by DBS, OCBC and now UOB as well, where the home loan interest rate is directly linked to their fixed deposit interest rate.
That means that should they want to increase your home loan interest rate, they’ll need to increase their fixed deposit interest rates as well. This generally keeps the interest rate from fluctuating too much, because an increase also means the bank will have to pay out more money to its deposit accounts as well.
How to Apply for Refinancing
Applying for refinancing starts with getting information pertaining to your current home loan. Give the bank a ring and a mortgage specialist there will be able to tell you vital information you need to consider:
- What is my current interest rate?
- How long will this last for? (Rate review date)
- How many years left do I have on my mortgage?
- Are there any penalties if I refinance to another bank now?
- What sort of repricing packages can you offer me?
How do you feel about the recent increase in SIBOR? Do you feel pressured to refinance before it gets higher? Share your thoughts with us.