When and why should you do mortgage refinancing

7 min read
Understanding the principles of home mortgage refinancing may be complex, but it helps you save money in the long run
Understanding the principles of home mortgage refinancing may be complex, but it helps you save money in the long run

Home loan rates in Singapore have been rising for some time. In fact, the current Singapore Interbank Offered Rate (SIBOR), to which many loans are pegged, is almost double what it was in 2014. This has led many to do mortgage refinancing on their loans, in order to minimise their monthly repayments. Whether you’re a home owner or an investor, it pays to understand how the process works.

What is mortgage refinancing?

Mortgage refinancing occurs when you switch one home loan package for another. This is often done when there are cheaper home loans available.

The process of switching your loan package to another is called refinancing, if you are switching to a package from another bank. If you are switching to a package offered by your current bank, it is called repricing.

The main difference between refinancing and repricing is cost. Refinancing usually entails some kind of conveyancing fee, to handle the legal paperwork. This is often between $1,500 to $3,000. Repricing will be cheaper (usually around $500), as your loan is not transferred to another bank.

The cost of mortgage refinancing and repricing can be paid from your CPF.

Some loan packages have “free repricing options”, which means there is no cost for repricing. Speak to the bank about the terms and conditions, but remember that repricing is not the same as mortgage refinancing; you must be getting a package from the same bank for it to count as repricing.

Why would someone do mortgage refinancing?

The structure of most home loans in Singapore are similar: the interest rates will be low for the first three years, but rise significantly on the fourth year and beyond. For example, a typical home loan package might look like this:

Savings@2x

As such, many home owners and investors seek to refinance on the fourth year, when the rate rises. A lower interest rate will result in lower monthly repayments. For example:

Say you purchase a condo for $1 million, for which you get a loan of $800,000. The loan package has an interest rate of 1.5 percent for the first three years, and an interest rate of 2.2 percent on the fourth year and thereafter.

Your loan repayment per month, for the first three years, will be around $3,199. From the fourth year onward, your monthly repayment would be around $3,438.

Now say on the fourth year, you refinance into a package with a lower rate. You pay $3,000 for the relevant fees. The interest rates on your new package are 1.2 percent for the first three years, and an interest rate of 1.9 percent for the fourth year onward.

Refinance@2x (1)

Your loan repayment per month, for the first three years, will be around $3,097 per month. Your loan repayments from the fourth year onward will be around $3,321 per month.

In the first three years of your new package, you would save around $341 per month. That comes to $9,276 (minus $3,000 for the fees) saved over three years. From the fourth year through to the end of your loan tenure you would save $117 per month.

The total savings come to almost $36,000, at the end of the loan (note: this is a rough estimate, the mortgage banker or broker can work out a more exact comparison for you.)

For investors, minimising repayments is important to preserve capital gains. The more interest you pay on your loan, the less profit you make upon resale. If you rent out the house, lower monthly repayments are important as you want rental income to exceed the monthly repayment.

For home-owners, don’t be misled by the apparently small monthly savings. Note how in the above example, the difference of a few hundred dollars a month comes to almost $36,000 by the end of the loan. If you hoard all the savings, it’s enough to send a grandchild through university.

A second reason to refinance: Switching from floating to fixed rates

At present, interest rates are rising. Home owners and investors who have a floating rate (pegged to SIBOR) may seek to keep repayments low, by refinancing into a fixed rate package.

For example:

A floating rate package has a rate of 0.7% + 3M SIBOR. If the SIBOR rate is 0.8 percent, the interest rate is (0.7% + 0.8%)1.5 percent. If the SIBOR rate rises to one percent, the interest rate would be (0.7% + 1%) 1.7 percent.

A fixed rate package is not pegged to SIBOR. If the rate is 1.5 percent, it will remain 1.5 percent for the duration of the fixed rate period, regardless of how SIBOR fluctuates.

As the SIBOR rate is expected to reach one percent by the end of 2016, many borrowers are now seeking to fixed rate packages to protect themselves from interest rate hikes.

A third reason to refinance: switching from HDB loans to a bank loan

Bank loan rates have been lower than HDB rates since around 2008. The HDB loan rate is always 0.1 percent above the CPF Ordinary Account (OA) rate. The OA rate is revised quarterly, but rarely changes.

At present the HDB loan rate is around 2.6 percent per annum, whereas bank rates are around 1.9 percent.

Some borrowers may have used a HDB loan to buy a flat at first, as HDB loans can finance up to 90 percent of the flat price. A bank loan can only finance up to 80 percent. These borrowers sometimes refinance into a bank loan after purchasing their flat.

(Note: you can still use CPF to pay for the mortgage, even after you switch to a bank loan.)

Who should do mortgage refinancing?

The people who should consider mortgage refinancing are:

  • People on the fourth year of their loan package, who are not under a lock-in
  • Landlords who need to keep repayments low
  • Investors who are looking to sell in the short term
  • Home owners who are on a tight budget
  • People on the fourth year of their loan package, who are not under a lock-in

As mentioned above, interest rates rise on the fourth year. This is usually when you want to refinance. However, do not do so if your loan package has a lock-in clause. The clause is usually valid for three to five years, and refinancing while under the clause will incur a penalty.

A typical penalty is 1.5 percent of the loan quantum (e.g. For a loan of $800,000, you would pay $12,000.) Speak to a mortgage broker for advice, but as a rule of thumb, this penalty is seldom worth paying.

Note that a fixed rate package is always locked-in. A five-year fixed rate means a lock-in clause for all five years.

  • Landlords who need to keep repayments low

Landlords should optimise the income they get out of their property, by constantly refinancing into the lowest rates.

  • Investors who are looking to sell in the short term

If you are looking to sell the house in five to seven years, there is no need to be overly concerned with “fourth year and thereafter” rates. You can consider finding packages with the lowest rates for three years, and proactively refinance into a cheaper package on the fourth.

The less interest you pay, the higher your eventual profits.

  • Home owners who are on a tight budget

If you need to tighten your belt for some reason, one of the first steps should be to reduce your debt obligations. Just as you would reduce interest repayments for your other loans (e.g. Pay a high interest credit card loan with a low interest personal loan), you should consider lowering your mortgage repayments. This can be done by strategic refinancing.

Home owners who are unfamiliar with refinancing can look for a mortgage broker. These brokers can handle the paperwork and refer you to the cheapest bank, and the service is often free (they will be paid by the banks for helping you to refinance.)

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