To refinance or not to refinance?

We look at the various criteria you should consider before taking the plunge

WITH ever lower interbank rates, it would seem that refinancing your home loan is a good idea. You could save on loan servicing costs and avail of a number of incentives, including the absorption by banks of the penalty costs that you may incur.

But think again. The ongoing credit crunch has led banks to tighten their lending criteria as ‘overall lending conditions have changed’, says a banker who declines to be named.

In addition, softer property prices suggest that some borrowers may have to top up their home equity to be able to refinance their loans. This applies for property that was bought between 2007 and early 2008.

Even as the three-month Sibor rate continues to trend downwards - it is currently 0.69 per cent compared to 2.22 per cent in September - the spreads that the banks will charge above Sibor appear to be on the increase.

HSBC, for instance, which last September offered a margin spread against Sibor of 0.75 per cent, has raised the spread to 1.3 per cent. For home loans with no lock-in periods, some banks are charging an interest spread of as much as 1.75 per cent. A higher spread will compensate banks for risk as well as give them a better margin, even though deposit rates remain low.

Sibor isn’t the only benchmark that banks use. Some banks have chosen to use the three-month swap offer rate (SOR), which includes Sibor as a component. Hence, the SOR rate is higher than Sibor. The three month SOR is currently at 0.87 per cent, compared to 2.11 per cent in October.

Says Dennis Ng, who runs mortgage consultancy www.housingloanSG.com: ‘In general, risk has increased on a macro basis. Transaction volume of properties has gone down and there are retrenchments.’

Patrick Tan, director of Morgan Mortgage International, a mortgage consultancy set up last year, notes that some banks are applying a form of ‘risk-based’ pricing on their criteria, taking into account factors including applicants’ professions or jobs; the loan to value ratio; loan to income ratio as well as whether the property is an investment property or for owner occupation. Banks also tend to prefer a borrower to be employed, rather than self-employed, although the scale of expected job losses suggests that few jobs are secure.

DBS, for instance, has spelt out clearly on its website its rates for a number of permutations, depending on the loan to value quantum; whether the property is for owner occupation or investment; and whether the property is still under construction.

For instance, a borrower seeking a 90 per cent loan for an owner occupied property will pay Sibor plus 2.75 per cent for a completed property. For an investment property the spread rises to 3 per cent. The spread rises further to 3.5 per cent for an investment property that is still under construction.

Mr Ng believes refinancing should not be a problem for those with a strong credit profile. House price valuation, however, is another issue. ‘There are instances where we check with banks and everything seems ok, and a month later the valuation has changed. Even though we had pre-approval, the bank will still adjust the valuation.’

Clients who had bought their properties earlier may not have to make any home equity top-ups. ‘Prices went up 100 to 200 per cent in the last four to five years. If you bought your property more than two years ago, the current value should still be higher.’

Morgan’s Mr Tan believes Sibor and SOR rates could stay low for the near term, but the spreads that customers must pay are trending up. ‘Those who are out of any lock-in period should consider refinancing before they miss the opportunity.’

Some clients, however, still prefer the peace of mind that comes from a fixed rate. So far, among the packages surveyed by Morgan, one of the most attractive appears to be that offered by Standard Chartered Bank, where the first year fixed rate is 2.18 per cent, followed by 2.49 per cent in the second year.

Recognising that some clients prefer visibility in their mortgage payments, UOB has a package, dubbed ‘Clear’, where the monthly instalment is fixed for three years, even though the interest rate is pegged to the SOR. If the SOR falls, any excess payment goes towards servicing principal. If the SOR rises to the extent that the interest on the outstanding balance exceeds the monthly instalment, the customer will have to pay the difference.

As refinancing involves switching banks, borrowers will typically be charged a penalty of 1.5 per cent of the loan amount as a full redemption penalty by their existing bank. Mr Tan says some banks will absorb this cost, subject to a clawback if the borrower switches banks again within the lock-in period.

Meanwhile, if you are keen to explore refinancing your loan, consider the services of a mortgage broker, who can compile rates, costs and benefits for you. Most banks are open to dealing with brokers, although one bank has set criteria that brokers need to meet to be on its panel of agents.

The fee paid to brokers or property agents - who also refer clients to banks - is said to be competitive. Mr Ng says: ‘We try to match clients with the banks. Some banks are very strict on the loan to income ratio. Some banks may look at whether the client holds other assets and relationships with institutions . . . We help clients to find an institution that will welcome them.’ While banks generally deem a 50 per cent loan to income ratio as acceptable, a more prudent ratio is 30 per cent, he adds.

While loan applications for new property purchases have plunged along with a moribund property market, most of the volume has so far been driven by refinancing. Demand for the latter, however, may also soften going forward.

Mr Ng says: ‘Refinancing may become difficult. Recently we had some cases where we advised them to stick with the same bank even though it didn’t give them the best rates. If they switched banks, they would have to come up with cash for a top-up as the current valuation is 10 per cent lower. We’re starting to see some of these cases. Others should be able to refinance - as long as they keep their jobs.’