Fine art of mortgage refinancing

Source : Tue, Aug 03, 2010 - my paper

By Reico Wong

A PROPERTY is, perhaps, one of the most expensive items a person will purchase in his lifetime, and the mortgage debt is often a big concern for many.

However, there are various means through which one can significantly manage such debt and gain financial freedom quickly.

Besides cultivating sharp financial habits to spend less and save more to pay off the loan early, financial experts recommend that one should also look closely into mortgage-refinancing options.

After all, as Mr Dennis Ng - founder of mortgage-consultancy portal HousingLoan.sg - highlighted, there are over 100 housing-loan packages available on the market at any time, and each has its pros and cons.

Admittedly, replacing one mortgage loan with another may be a complex process, but the potential financial advantages are worth the effort.

The key reason why individuals may choose to refinance their loans is to capitalise on lower interest rates, which allow them to pay less in the long run.

Even a small difference in the monthly interest payable for the loan taken out can result in savings of thousands of dollars.

Similarly, refinancing options can lead to one having more cash in hand on a monthly basis for exigencies.

Another reason one might be interested in refinancing a loan is to either shorten or extend the amortisation period on the mortgage, because of lifestyle changes.

Choices aplenty

A couple entering their retirement years, for example, might find it more suitable to extend the loan-repayment period but make smaller payments each month, in view of their reduced income.

In a case where an individual has increased means to repay the mortgage with, he may want to restructure his loan such that the monthly payments are higher but interest rates lower.

By decreasing the repayment period of the loan, he will be able to become debt-free earlier and also enjoy substantial savings in the long run.

Refinancing a loan with a floating interest rate to get a fixed rate might prove beneficial, too.

Interest rates for the housing market tend to fluctuate quite a bit, so the switch to a fixed rate might make it easier to plan more accurately for one's expenses.

This also translates to more financial stability and security.

Additionally, there will be savings once again if one manages to lock in a low fixed interest rate for the loan, while floating rates climb.

When not to refinance

Having said that, experts also caution that there are certain times when loan refinancing could be a bad decision.

An example is if the individual has only a few years left on a current loan or plans to sell his property in the short term.

This is because most refinancing loans come with a lock-in period of two to three years, and there are penalties for breaking this clause, pointed out Mr Greg Zeeman, head of personal financial services at HSBC Bank.

The penalty is applicable even after the property is sold and the individual no longer needs the loan. Refinancing would, hence, pull one only deeper into debt.

Therefore, strict attention must be paid to both the penalty period and fees stated for a mortgage package.

One should also check to see if there are advanced or accelerated payment options at the very beginning. Flexibility to make repayments at times would come in useful, too.

Likewise, it is critical that one considers the total expense of refinancing.

Mr Ng said: "If you plan to sell your property within the next 12 months, it probably does not make sense to refinance as, typically, you need to give three months' notice to your bank before moving your home loan to another bank.

"If you sell your property in nine months' time, it means you enjoy interest savings for only six months, and these interest savings might not be much higher than the cost of refinancing."

Costs such as application processing, property valuation and credit- reporting fees apply.

There are also legal costs involved, which can be huge.

"Customers should check if the new loan comes with any legal- fee subsidy and whether it is sufficient to cover the cost," said Mr Zeeman.

One also needs to check that there is sufficient equity in the property before taking up a refinancing option - ensure that its value has not dropped significantly.

Refinancing is not advisable if the home-equity value of the property is low - say, less than 20 per cent - and the loan amount is huge. The new loan, at the lower appraised value, might not be sufficient to pay down the original mortgage.

For the same reasons, it is best not to refinance if one's home equity has already been reduced by a second mortgage or home-equity loan.

Experts said that in such cases, the individual probably will also not qualify for loans with the best interest rates, no matter how good his credit score is.

Don't rush into it

Note that one does not necessarily have to switch financiers when refinancing a loan.

Certain lenders offer customers loyalty discounts in the form of a year-on-year decrease in the interest-rate spread charged, or even no lock-in period for staying on with them.

There are also loan-portability features for loyal customers.

HSBC, for instance, has a programme under which customers can continue where they left off on a sliding interest rate if they take a new mortgage with the bank after selling their property and redeeming the original loan.

Ultimately, refinancing must be done for the right reasons and at the right time.

Shop around for the best refinancing deal suited to your needs. Don't be rushed into signing on the dotted line without fully understand all the terms and conditions.