Why consider refinancing?
Are you considering to refinance? Have interest rates fallen? Or do you expect them to go up? Would you like to switch into a different type of mortgage?
The answers to these questions will influence your decision to refinance your mortgage. But before deciding, you need to understand all that refinancing involves. Your home may be your most valuable financial asset, so you want to be careful when choosing a lender and specific mortgage terms. Remember that, along with the potential benefits to refinancing, there are also costs.
When you refinance, you pay off your existing mortgage and create a new one. Refinancing may remind you of what you went through in obtaining your original mortgage, since you may encounter many of the same procedures–and the same types of costs–the second time around.
a) Lowering your interest rate
The interest rate on your mortgage is tied directly to how much you pay on your mortgage each month–lower rates usually mean lower payments. You may be able to get a lower rate because of changes in the market conditions improved. A lower interest rate also may allow you to build equity in your home more quickly.
For example, compare the monthly payments (for principal and interest) on a 30-year loan of $500,000 at 3.5% and 4.0%.
b) Adjusting the length of your mortgage
Increase the term of your mortgage:
You may want a mortgage with a longer term to reduce the amount that you pay each month. However, this will also increase the length of time you will make mortgage payments and the total amount that you end up paying toward interest.
Decrease the term of your mortgage:
Shorter-term mortgages–for example, a 20-year mortgage instead of a 30-year mortgage. Plus, you pay off your loan sooner, further reducing your total interest costs. The trade-off is that your monthly payments usually are higher because you are paying more of the principal each month.
For example, compare the total interest costs for a loan of $500,000 at 4% for 30 years with a loan for 20 years.
c) Changing from a Floating-rate mortgage to a Fixed-rate mortgage
If you have a floating-rate mortgage (SIBOR, SOR pegged), your monthly payments will change as the interest rate changes. With this kind of mortgage, your payments could increase or decrease.
You may find yourself uncomfortable with the prospect that your mortgage payments could go up. In this case, you may want to consider switching to a fixed-rate mortgage to give yourself some peace of mind by having a steady interest rate and monthly payment. You also might prefer a fixed-rate mortgage if you think interest rates will be increasing in the future.
d) Getting a Floating-rate mortgage with better terms
If you currently have a floating-rate, will the next interest rate adjustment increase your monthly payments substantially? Example from year 2 to year 3. You may choose to refinance to get another floating-rate mortgage with better terms. For example, the new loan may start out at a lower interest rate. Or the new loan may offer smaller interest rate adjustments.
e) Getting cash out from the equity built up in your home
Home equity is the dollar-value difference between the balance you owe on your mortgage and the value of your property. When you refinance for an amount greater than what you owe on your home, you can receive the difference in a cash payment (this is called a cash-out refinancing). You might choose to do this, for example, if you need cash to make home improvements or pay for a child’s education. Because you are using your property to get a loan, do make sure you are confident in making the monthly payment. If you missed your payments, you may risk losing your property. Home equity loan is only applicable to private residential property and not HDB flats.
When is refinancing not a good idea?
a) You’ve had your mortgage for a long time.
The amortization chart shows that the proportion of your payment that is credited to the principal of your loan increases each year, while the proportion credited to the interest decreases each year. In the later years of your mortgage, more of your payment applies to principal and helps build equity. By refinancing late in your mortgage, you will restart the amortization process, and most of your monthly payment will be credited to paying interest again and not to building equity.
b) Your current mortgage has a prepayment penalty
A prepayment penalty is a fee that lenders might charge if you pay off your mortgage loan early, including for refinancing. If you are refinancing with the same lender, ask whether the prepayment penalty can be waived. You should carefully consider the costs of any prepayment penalty against the savings you expect to gain from refinancing.
c) You plan to move from your home in the next few years.
The monthly savings gained from lower monthly payments may not exceed the costs of refinancing (legal clawback, prepayment penalty, redemption penalty) –a break-even calculation will help you determine whether it is worthwhile to refinance, if you are planning to move in the near future.
Are you eligible to refinance?
Determining your eligibility for refinancing is similar to the approval process that you went through with your first mortgage. Your lender will consider your income and assets, credit rating, other debts, the current value of the property, and the amount you want to borrow.
Lenders will look at the amount of the loan you request and the value of your home, determined from a valuation. If the loan-to-value (LTV) ratio does not fall within their lending guidelines, they may not be willing to make a loan.
If housing prices fall, your home may not be worth as much as you owe on the mortgage. If this is the case, it could be difficult for you to refinance.
How can you shop for your new loan?
Talk to your current lender
If you plan to refinance, you may want to start with your current lender. That lender may want to keep your business, and may be willing to reduce or eliminate some of the typical refinancing fees or offers a lower rate.
Compare loans before deciding
Shop around and compare all the terms that different lenders offer–both interest rates and costs. Remember, shopping, comparing, and negotiating can save you thousands of dollars.
Use newspapers and the Internet to shop
Newspaper and the Internet are good places to start shopping for a loan. You can usually find information on interest rates offered by several lenders.
Be careful with advertisements
The cheapest rate may not be the most suitable package for you. Some of these packages requires you to have a banking relationship with the lender or are only available to customers who obtain certain credit ratings.
Although this information can be helpful, keep in mind that these are marketing materials–the ads and mailings are designed to make the mortgage look as attractive as possible. These advertisements may play up low initial interest rates and monthly payments, without emphasizing that those rates and payments could increase substantially later. So get all the facts and make sure any offers you consider meet your financial needs.
Choosing a mortgage may be the most important financial decision you will make. You should get all the information you need to make the right decision. Ask questions about loan features when you talk to lenders –and keep asking until you get clear and complete answers.