Singapore — Your home loan is probably the single biggest financial commitment you’ll ever take on, and one you could spend the next few decades paying for. Given the magnitude, you obviously want to ensure you lighten the load as much as possible. That’s why it’s so important to be aware of when it’s time to refinance your home loan.
It can save you thousands of dollars over the years, raise your capital gains on resale and basically make your expensive home purchase a bit less expensive.
What is refinancing?
Refinancing means ending your existing home loan package, and carrying on repayments with another bank’s package.
Here’s an example:
Let’s say my current home loan package is a 2% SIBOR home loan package from Bank X. After a few years of repaying this loan, I notice that Bank Y is offering a better interest rate at 1.6%. When I jump ship from Bank X to Bank Y, I am refinancing.
Refinancing is a common practice in Singapore’s property industry. This is because home loan interest rates change all the time, and borrowers must be on the lookout for better rates. Also, there are no loyalty rewards for staying with the same bank.
Is refinancing the same thing as repricing?
The short answer is: no.
Repricing is the process of switching between home loan packages within the same bank, while refinancing involves switching to a loan package offered by a different bank.
Here’s a quick and easy example of repricing.
Let’s say I currently am signed up to Home Loan Package A from Bank X with a 2% interest rate. After a few years of repaying this loan, I notice that the very same Bank X is now offering Home Loan Package B with a better interest rate at 1.6%. If I switch from Package A to Package B, I’m repricing.
It is important to note the difference, because some banks offer one “free” repricing (often called “free conversion”). In this case, the bank will allow you to move between its loan packages without incurring any costs (which is typically an “admin fee” of about $800).
But never assume that repricing (even for the first time) will be free. Be sure to verify the details with your bank.
As a general rule, you should refinance to a different bank so long as you satisfy all of these 3 conditions:
- You are out of your bank’s lock-in period if any
- You are out of your bank’s claw-back period if any
- There are other banks offering better interest rates than your current bank
How Much Does Refinancing Cost?
In the long-run, refinancing can save you money. But in order to refinance, you will have to bear certain costs.
Some loan packages come with a lock-in clause.
A lock-in usually lasts for two to five years. Should you refinance within this time, you will have to pay a penalty (often 1.5% of the remaining loan amount). In general, it is not advisable to break a lock-in, as the pre-payment penalty is substantial.
The reason banks impose this penalty is because refinancing deprives them of further making money from you through the interest payable. The penalty acts as a form of insurance to the banks.
Before the MAS rulings in October 2012, banks used to pay certain subsidies for borrowers. This included fees like legal costs, valuation, and fire insurance, which could total around $2,000 to $3,000.
For these subsidies, the banks typically retained a three-year right of clawback. If you have one of these packages, and you refinance within three years of your loan approval, you must pay back the subsidies.
Since October 2012, banks have no longer been allowed to pay these subsidies. So when you refinance, you will have to pay any legal fees, fire insurance, etc. to the new bank yourself. As before, the costs are around $2,000 – $3,000. You can use your CPF to pay these costs.
Granted, the vast majority of loans are now free of their clawback periods, but to be sure, check that yours is over before attempting to refinance.
If you break the clawback and refinance to a new bank, you will have to pay the clawback fees to the old banks plus any legal fees, fire insurance, etc. to the new bank. That could add up to around $4,000 – $6,000 total depending on your property type. So avoid “double paying” by refinancing only after your clawback period is over.
When Should We Refinance?
Just as there is an auspicious hour at which to get married, which is why so many bridesmaids/groomsmen find themselves waking up at 3am to prepare for their friends’ weddings, there are good and bad times to refinance. The best times to refinance are when:
A Better Package is On Offer
The home loans market is dynamic, with banks changing their offers every month. While your loan package may have been the best some years ago, it is unlikely to stay that way.
The typical home loan package has “teaser rates” for the first two to three years, during which interest rates are kept low.
From the third or fourth year onward, there is usually a significant rate hike. This is when most borrowers are advised (even by the bankers themselves) to consider refinancing.
But how do you know if there is a better package out there?
The best way to know is to compare all the available loan packages. You can do this very quickly, and for free right here on MoneySmart. With over 12 banks offering home loans, it’s unlikely that you won’t find a better deal at some point.
When choosing a new package to refinance into, you’re looking for something that’s significantly cheaper. There should be a difference of at least 0.5% between your existing interest rate and the new one. Otherwise, it might not be worth your time. If your remaining loan amount is high (say over $1 million), a difference of even 0.5% can still translate to significant savings.
You Need to Change Loan Tenure
For some borrowers, the problem is not the overall cost of the loan, but the amount of their monthly repayments. Refinancing can help in these cases too.
When you refinance a loan, you can change the loan tenure so long as the total tenure does not exceed 30 years (if you want to know why and how loan tenures are calculated, check out this article).
Let’s say you pick a loan package with a tenure of 25 years.
Five years later, you’ve quit your job as a banker to become an artist, and the monthly repayments are now too high for you.
Refinancing can enable you to pick a package with a tenure of 30 years instead.
While stretching the loan by five years will increase the overall cost (due to interest), it will decrease the monthly repayments.
Savings Meet or Exceed Costs Within the Year
Sticking with the same package for the entire duration of your loan can cost more than refinancing. That’s because you’ll be stuck paying a lousy interest rate till kingdom come.
Of course, to know how much you’d save by refinancing, you’ll have to do the math.
The first step is to calculate how much your new monthly repayments would be if you refinanced to a new package. Compared to your existing repayments, how much will you save with the new loan package?
The total amount saved should meet or exceed the cost of refinancing, within a recommended period of 12 months. For example, if refinancing will save you about $200 a month with the new loan but cost an additional $1,000 upfront in legal fees, it will technically take you $1000 divided by $200 = 5 months to break even before real savings kick in. You will then have to ask yourself if it’s worth that five month wait before your refinancing pays off.