TFN Editorial Team. 01 May 2016
What is refinancing?
Refinancing may refer to the replacement of an existing financing/debt with a new financing under different terms. For the case of mortgage loans, it means to pay off a current loan and to get a new loan with better terms(lower interest rate) through another bank.
When to refinance?
As previously mentioned, the purpose of refinancing is to lower the interest rate and pay less interest. As such, the best time to refinance is when the interest rate on your existing mortgage loan starts going up, which is typically when the loan is past its lock-in period (but not always the case).
Aside from the interest rate, there are a few other key considerations to take note when weighing up the costs of refinancing.
Legal fee is applicable for all loans that have been accepted, and ranges from $1,500 to $3,000 for most cases (typically costs $2000 or less for normal cases that the banks assign to law firms on their panel). Some banks offer a legal fee subsidy which could be as high as 0.4% of the loan amount capped at say $2,000, but may not always be the case and depend on individual bank.
Lock-in period and Redemption penalty
A lock-in period is the period where a borrower will incur a redemption penalty should he make partial/full repayment of the loan or chooses to refinance to another bank. The lock-in period typically ranges anywhere from 1 to 3 years. There are some packages in the market that comes without a lock-in period. So, pay attention to this clause when searching for your next loan.
As previously mentioned, legal fees is incurred because a lawyer is needed to act on behalf of both borrower and lender. Most banks used to provide a legal fee subsidy for new loans until a MAS ruling a few years back which led banks to stop giving legal fee subsidy for new home loans. Currently, legal fee subsidy is available only for refinancing cases. Usually, the clawback period is 3 years. This means that should you refinance your loan with another bank, the existing bank will clawback the legal fee subsidy given to you when you first took up the loan with them.
Typically ranges between $300 and $500, and applies to both repricing and refinancing.
Refinancing vs repricing
Both refinancing and repricing have the objective of lowering the interest costs, but refinancing refers to redeeming the existing loan and refinancing it with another bank, while repricing refers to requesting for a lower rate package with the same bank. There is a valuation fee involved for both options. In addition, refinancing will incur legal fees (typically up to $2,000 that may be offset by the legal subsidy from the new bank) and repricing will incur an admin fee (typically $500 to $1000) from the existing bank.
In general, if you are out of your lock-in and clawback period, and if the outstanding loan is relatively huge, and the rates of your existing loan package have gone up substantially versus rates for new loans,it will (most likely) be economically worthwhile to refinance. However, you will need to do a cost-benefit analysis and consider in the above-mentioned factors before deciding whether it is worthwhile to do so.
Let's take a look at two examples:
Current Interest Rate: 2.2%
Balance loan amount: $400,000
Out of lock-in
Within clawback period, previous legal subsidy of $2000
New bank offering 1.7% for first 2 years, no legal subsidy
0.5% x $400,000 x 2 years = $4,000 (estimated, actual figure will be lower due to lower year2 balance)
Legal Fee - $2,000
Legal Clawback - $2,000
Valuation fee - $400
Net Savings = $4,000 - $2000 legal fee - $2000 legal clawback -$400 valuation fee = (-$400)
As we can see from the above example, due to the legal fee, clawback, and valuation fee, it is not worthwhile to refinance.
Current Interest Rate: 2.2%
Balance loan amount:$1,000,000
Out of lock-in and clawback period
New bank offering 1.7% for first two years, legal subsidy capped at $2,000 and fully covers legal fee
0.5% x $1,000,000 x 2 years = $10,000
Net savings = $10,000 - $400 valuation fee = $9,600
As we can see, due to the large loan balance, legal subsidy and no clawback, in this example we would see significant savings should we choose to refinance.
If you would like a free, non-obligatory consultation to work out the overall interest savings or have some general enquiries about your financing and refinancing, drop us an email at firstname.lastname@example.org.