“To save money” and to unlock cash reserves from your home tops the list of most common reasons for refinancing.
What are some of the reasons for refinancing?
a. Reduce interest payment
For most people, saving on interest payment is a main motivation for refinancing. Typically, the interest rate for a home loan increases after the first 2 or 3 years. This is true whether for a fixed or variable rate loan. Thus the refinancing numbers is highest after the fixed rate period ends, subject to other considerations.
Below illustrate how much borrowers can save from interest payment if they change to a loan with a lower interest rate.
Current loan:
Outstanding loan amount: $800,000
Interest rate: 3.5% fixed for 3 years
Tenure: 30 years
| Year | Monthly Installment | Monthly Principal Paid | Monthly Interest Paid | Annual Principal Paid | Annual Interest Paid | Balance |
| 1 | $3,592.36 | $1,300.01 | $2,292.35 | $15,353.02 | $27,755.27 | $784,646,98 |
| 2 | $3,592.36 | $1,346.25 | $2,246.11 | $15,899.08 | $27,209.21 | $768,747.89 |
| 3 | $3,592.36 | $1,394.13 | $2,198.23 | $16,464.57 | $26,643.72 | $752,283.33 |
Total interest paid over 3 years is $81,608
New loan:
If you are able to refinance your loan to a lower rate, for example:
Year 1 – SIBOR + 1% (Assume that SIBOR = 0.5%) = 1.5%
Year 2 – SIBOR + 1% (Assume that SIBOR = 1%) = 2%
Year 3 – SIBOR + 1% (Assume that SIBOR = 1.5%) = 2.5%
| Year | Monthly Installment | Monthly Principal Paid | Monthly Interest Paid | Annual Principal Paid | Annual Interest Paid | Balance |
| 1 | $2,760.96 | $1,785.33 | $975.63 | $21,277.43 | $11,854.11 | $778,722.57 |
| 2 | $2,950.84 | $1,683.53 | $1,267.31 | $20,018.45 | $15,391.61 | $758,704.12 |
| 3 | $3,142.08 | $1,597.61 | $1,544.48 | $18,953.58 | $18,751.41 | $739.750.55 |
Total interest paid over 3 years is $45,997.13.
The difference in interest payment ($81,608 – $45,997.13) is $35,610.87! Imagine you can pay for 3 Rolex watches or a 2 – to 3- carat diamond ring with this amount.
But, of course, there are other considerations in refinancing such as the person’s age, the outstanding loan tenure applicable as well as his/her debt servicing ratio, credit situation and etc. These will be dealt with in another article.
b. Change loan duration
For some people, they may have an unexpected increase in financial obligation or have suffered a pay cut. This makes servicing of the loan at the current monthly installment amount difficult to sustain. As a result, taking a longer duration loan to reduce on the monthly payment becomes desirable, although the interest payable over the entire life of the loan will be higher.
c. Change in credit standing
Conversely, for others their financial strengths may have improved since they first took the loan, so they may want to refinance to a shorter duration loan to save on interest payment. Or that they may have improved their credit standing enough to have a wider choice of bank packages.
d. Change in interest rate environment
If the interest rate environment has become dovish, reducing the loan tenure may not even significantly increase the monthly repayment amount. This can translate to interest savings over the entire life of the loan. For example, paying $800 per month over 30 years adds up to $288,000; whereas paying $850 over 25 years, sums up to $255,000. (However, do note that this is a simplified example as it simply adds up the interest costs over the years at nominal value without considering the time-value of money.)
e. Change the type of home loan packages
According to circumstances, borrowers may like to change the type of home loan package.
A case in point:
During a low-interest rate climate, savvy borrowers may prefer to capitalise on low interest payments by taking a market-pegged interest rate variable package. But when these borrowers think that interest rates are starting to climb, they may try to change the loan to a fixed rate package for some years so as to be able to lock in lower rates and better manage their cash flow. Fixed rate packages are usually more expensive, but provide the most stability as rates are kept fixed for up to the first 3 to 5 years of the loan tenure. There is no perpetual fixed rate being offered by banks in Singapore at the current moment.
f. Some refinance to obtain cash out; generally known as equity loan (Not applicable to HDB flats)
Home owners can secure cash via an equity loan by refinancing. The terminologies of equity loan and term loan are loosely interchangeable, though the correct terminology should be called equity loan. When there is sufficient equity in the property, banks may allow borrowers to take out an equity loan (term loan) secured by the property. A term loan secured against a property cannot be used as down-payment towards another property. This is MAS’ way to prevent the risks of property market bubble from forming.
Nonetheless, it is advisable to take a term loan only if the borrower can hope to make a better return from this cash-out to offset the additional interest incurred from the larger quantum loan.
Fixed versus floating interest rates – you need to know them before deciding on the right reasons for refinancing.
| FIXED | FLOATING |
|---|---|
| Interest rate on your home loan remains fixed throughout the loan tenure. | Interest rate on your home loan changes based on change in the lender’s benchmark rate. |
| Fixed rates are slightly higher than floating rates. | Floating rates are slightly lower than fixed rates. |
| If you are comfortable with the prevailing interest rates, are reasonably sure that interest rates will rise in future, opt for a fixed rate home loan. | If you are unsure about where interest rates are heading, opt for a floating rate home loan. |
| There is a prepayment penalty in case of fixed rate home loans. | There is no prepayment penalty in case of floating rate home loans. |
But most importantly, anyone who wants to refinance should read up on a good refinancing guide. They should also speak to a professional mortgage consultant to get the best home loan which is tailor-made for them.
Saving money through refinancing can be achieved in two ways:
- By obtaining a lower interest rate that causes one’s monthly mortgage payment to be reduced
- By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 25-year loan to a 15-year loan might result in higher monthly payments, but the total interest paid during the life of the loan can be reduced significantly.
Stability And Security & Consolidate Debt
Other common reasons for refinancing are to convert their adjustable loan to a fixed loan, and to consolidate debts by replacing high-rate loans with a low-rate mortgage.
The main reason for doing this is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.
Another reason why homeowners refinance is to consolidate debts and replace high-rate loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumer loans are not tax deductible, while a mortgage loan is usually tax deductible.
Does Refinancing Add Up?
The answer to the question, “Should I refinance?” is a complex one, since every situation is different and no two homeowners are in the exact same situation. If you are refinancing to lower your monthly payments, the following calculation can be used as a general guide:
- Calculate the total cost of the refinance–example: $2,000
- Calculate the monthly savings–example: $100/month
- Divide the result in 1 by the result in 2–in this case 2000/100 = 20 months. This shows the break-even time period. If you plan to live in the home for longer than this period of time, it likely makes sense to refinance.
Balloon About To Pop?
Sometimes, you do not have time to consider the most common refinancing reasons as you may not have a choice – you are forced to refinance.
This happens when you have a loan with a balloon payment and no conversion option. In this case it is best to refinance a few months before the balloon payment is due. Whatever your reason for refinancing, consulting with a seasoned mortgage professional can save you time and money.
Today, consumers have a wide range of home loan packages to choose from compared to 10 years ago. Home loans could also be tied up with programmes offered by banks such as the DBS Multiplier, which rewards customers with a higher interest rate on their deposits if they transact more with the bank, such as getting a home loan and crediting your salary to the bank. Do consider the offerings in the market.
Can a new loan offer you savings? Typically, a home loan package offers attractive rates for the first three years, following which the interest rates are adjusted upwards, which usually coincides with the end of the lock in period, offering borrowers a good opportunity to relook their loan.
In considering some of these reasons for refinancing, you should also not ignore the personal factors.
Factors like:
- Refinancing a home loan would mean reassessing your credit standing.
- Has your salary increased/decreased since the last assessment?
- Have you taken up more loans?
- Have you been paying your bills on time?
These factors will affect your credit score and willingness of the bank to refinance your loan.
Banks can come up with customised solutions to meet your needs whether it is to change the loan tenure or lower your monthly payments. Find the bank that offers you the best solutions. However, do note that generally if you stretch your loan tenure over a longer period, the interest payable at end of loan is higher.
Refinancing a home loan can offer you an opportunity to unlock cash from property. This alone would trump all refinancing reasons for most home owners seeking new mortgage loans.
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