It is not common in the world of real estate that all of the stars align. It may sometimes be hard to match a good deal on a property with ideal refinancing and low interest rates.
In this article, we discuss the reasons you may wish to refinance your property, how you can refinance and the benefits of doing so.
Let’s dive in.
Why you may wish to refinance your property
In previous articles, we mentioned the characteristics of a home loan. Namely, the lock-in period of the loan and the difference between a fixed and floating rate on your loan.
Home loans typically offer attractive rates at the beginning of the loan tenure. However, once your lock-in period has expired, you may realise that you are paying a higher interest rate than new products available in the market.
Consider a home loan of a private residential property that you contracted, charging an annual interest rate of 3.0%. If you are currently past your initial lock-in period, you may wish to capitalise on the recent movement on interest rate and refinance your property with another home loan at a more competitive interest rate.
Effectively, this enables you to manage your monthly debt obligations, thereby freeing up more capital for other investments.
Refinancing therefore typically brings benefit to you, the debt holder, through lower monthly payment by means of a more competitive interest rate or an extended loan tenure.
Ways to refinance your home loan
1. Switching Lenders
Let us have a quick recap.
Unlike the name implies, fixed rate mortgages do not charge a fixed rate for the entire loan tenure. Instead, they may charge a fixed rate for a short period of 2 to 3 years before reverting to an interest rate benchmark with an additional spread charged by the bank.
For example, assume you take on a loan with a bank for a 20-year loan, which has a fixed rate of 1.5% for 2 years. After this initial 2-year period, the interest rate on the home loan will revert to the interest rate benchmark plus spread, which results in an interest rate of 2.0%.
However, at the end of this 2-year period, you realise that a separate bank is offering home loans with an interest rate of 1.7%. To refinance in this situation, you would obtain a home loan from this second bank at a 1.7% interest rate. A portion of the loan amount goes towards paying off the outstanding balance of the first loan.
Without considering some additional costs in refinancing, refinancing in this situation has enabled you to save 0.3% of interest payments.
To properly calculate whether refinancing brings us savings, we would need to determine these additional costs involved in refinancing. This may include legal and valuation fees, which may amount to $2,000-3000.
Additionally, your first loan may impose certain pre-payment penalties for terminating the loan early. Furthermore, the second loan that you refinanced with may impose a clawback period, in which you will not be able to apply to refinance your property again.
Taking all these factors and additional costs into consideration, we can now properly consider if refinancing at this new rate brings us actual savings.
However, keep in mind that banks are always in competition with each other, especially in a low-interest rate environment. It is likely that refinancing packages and promotions include subsidies that cover these auxiliary costs, making it simpler and easier for you to consider if you wish to proceed.
We recommend speaking a mortgage broker to get the latest update on home loan products, and to walk you through any additional fees that you can expect to encounter.
2. Cash-out refinancing
Cash-out refinancing, also known as home equity loans, are a way for homeowners to utilise the value of their home as collateral to obtain larger loans.
A secured loan where your property is used as collateral reduces the risk that the lender is exposed to, as compared to an unsecured loan. Therefore, you do not need to compensate the bank for additional risk, translating to far more attractive interest rates for you.
How good of a deal that you can obtain through this as a borrower is dependent on the current market value of your property, and the outstanding loan amount on your home loan.
Do keep in mind that you would still need to maintain a Loan-to-Value (LTV) ratio of 25% on your property, which means that you will only be allowed to ‘cash out’ to a limit of 75% of your property value.
The option to use your property as collateral is, however, only available to private property owners as HDB owners may not use their property as collateral.
Benefits of Refinancing
1. Lowering your monthly debt obligations
Refinancing to a loan with a lower interest rate can effectively lower your monthly debt obligation. Alternatively, refinancing with a home loan that has a longer tenure than your existing loan can also reduce monthly payments.
Do keep in mind that having a longer loan tenure may in fact increase your overall interest payments (as opposed to simply repaying the amount owed) in the long run.
This is because you will still be incurring interest payments over a longer loan tenure.
These factors are important points of consideration when considering to refinance, as they tie into your long-term financial goals and ultimately, your real estate journey. Do speak to a mortgage advisor gain a more detailed understanding of how refinancing fits in with your unique goals.
2. Unlocking home equity
Utilising your home equity through cash-out refinancing effectively multiplies your ability to gain return on your capital. By withdrawing these funds as you deem necessary, you may be able to reinvest in other financial instruments. Financial instruments that offer a return above the interest rate charged on your mortgage.
Alternatively, you may wish to utilise the added funds for certain cash purposes such as education or entrepreneurship.
In all things, we advise prudence with managing loans secured by your property. After all, your home should be a place that gives you peace of mind, and not a reminder of an endless cycle of debt.
Is refinancing for you?
Refinancing is simply one of the many ways to optimise your real estate portfolio such that you are maximising your returns. If you are financing an investment property, or to reduce the monthly burden of debt.
We strongly advocate an understanding of any products that you wish to partake in. Do speak to any of our mortgage advisors to get a better lay of the land, and to plan your real estate roadmap. Refinancing is one of the many tools for you to be a savvy real estate investor!