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Can Refinancing Your Home Loan Actually Help You Save Money?

Refinance only if it helps you save money in the long run…

With interest rates set to rise, refinancing may seem like a prudent decision. However, it’s not always true that refinancing will get you a better deal. It comes up to much more than just comparing two different percentages – here’s what to watch for before signing a new deal:

The Rundown On Refinancing Your Home Loan

Refinancing is the process of switching your existing home loan package to a cheaper one.

For example, your current home loan rate is 1.9%. However, there is another home loan package on the market that is priced at 1.7%. You could refinance and switch from your existing package to the cheaper one.

In Singapore, most home loan packages follow a preset pattern: the interest rate is low for the first three years, and then jumps significantly on the fourth year. This forces a lot of borrowers (especially property investors) to refinance frequently.

Situations When Refinancing Your Home Loan Would Save You Money

Refinancing does not save you money in every situation. In fact, it can cost you more than what is is worth. In order to save money, refinancing should meet the following conditions:

  • There is no lock-in clause on your existing home loan package
  • The legal fees are repaid by the savings within a year
  • There are better loan packages on the market

In addition, you should understand the impact of changing your loan tenure when you refinance.

1. There Is No Lock-In Clause On Your Current Home Loan Package

Some home loan packages come with a lock-in. This usually lasts for around three years (exceptions exist). Note that, if you have a fixed rate package, the duration of the fixed rate is by default a lock-in (e.g. a fixed rate package of 1.7% for five years also means a lock-in period of five years).

Should you refinance during the lock-in period, you will have to pay a penalty. This is usually 1.5% of the undisbursed loan amount. In almost every case, this will mean losing more money than you would save.

Wait until the lock-in period is over before refinancing. If you insist on breaking the lock-in, speak to a mortgage specialist or wealth manager for advice. You are going to need someone who can pull strings in banks!

2. The Legal Fees Are Repaid By The Savings Within The Year

By lowering the interest rate of your home loan, you will save on monthly repayments (unless you have also shortened the loan tenure. See below). Ask the mortgage specialist to work out the exact dollar amount of your savings.

Unfortunately, refinancing is not free. There are legal costs involved, which can range between S$2,000 to S$3,000 (you can pay this with your CPF). As a rule of thumb, you should divide the refinancing cost by the savings per month – this will tell you how many months it takes to make up the refinancing cost.

For example:

If refinancing would cost S$2,000, and you would save S$150 a month, you would take (2000 / 150) = 13.3 months to make up the cost.

In general, you should not refinance if it would take more than 12 months to make up the legal costs.

3. There Are Better Loan Packages On The Market

Of course, there is no point refinancing if there is nothing better out there. That’s simple common sense. When deciding on this, remember to also factor in the final rate (fourth year and thereafter), rather than the teaser rates in the first three years.

So if your current home loan rate is 1.9% on the fourth year and thereafter, you might not want to pick a loan package that is 2.1% on the fourth year and thereafter – even if the new package is cheaper than yours for the first three years.

At present (October 2015), one of the lowest rate packages on the market is from UOB. However, this is subject to constant change.

Understand the impact of changing your loan tenure

You can extend or reduce your loan tenure when you refinance. If you extend the loan tenure, you will be paying less every month – an important consideration if you want good rental income, or are currently in a tight spot.

If you reduce the loan tenure, you will pay more each month. However, you will be paying less in the long run, as your interest rate cost will be lower.

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