The Ultimate Guide To Refinancing Posted : on 16/12/15
Mortgage is a very unique bank product. Why? This is because the collateral being used to secure a loan from the banks is property. Of all facilities you have taken up with your banks, your mortgage is one very unique product where the property value appreciates over time, while your loan depreciates over the time. With this in mind, this positive value asset can then be used to generate additional cash flow for you. Best of all, its nearly a free cash flow for you. More on why it is nearly free will be explained at a later part of this article. How this is achieved is via mortgage refinancing. Refinancing a mortgage means paying off an existing loan and replacing it with a new one.
There are many common reasons why homeowners or investors refinance their properties.
The opportunity to obtain a lower interest rate (This is where the mortgage was taken sometime ago when it was more expensive back then)
The chance to shorten your mortgage loan tenure
The opportunity to tap on the property latest market value in order to finance a new purchase;
The desire to convert to a different mortgage product type (fixed mortgage term loan, flexi mortgage loans or semi-flexi mortgage loan)
REFINANCE FOR LOWER INTEREST RATES/ EFFECTIVE LENDING RATES (ELR)
This is pretty straight forward, if a competitor bank offers you a 1% or 2% reduction in interest rates, you will definitely save from paying more interests. This also translates into a lower monthly installment. If you are renting this property out, you may be able to improve your rental cash flow position from a potentially negative to positive cash flow since the installment is lower now. See illustrations below.
|ELR 5.5%||ELR 4.5%|
|Monthly Installment(RM)||2, 839||2, 534|
|Rental Income(RM)||2, 839||2, 839|
|Savings/Positive Cash Flow(RM)||0||305|
|*Assumption: 1.Loan Amount is 500k, 2.Loan tenure of 30 years|
SHORTEN MORTGAGE TENURE
You may shorten your mortgage loan tenure when you refinance your house. This would allow you to have savings on total interest that you need to pay to the bank. See illustration below.
|Loan Tenure(RM)||30 years||25 years||20 years|
|Monthly Installment||2, 534||2, 780||3, 164|
|Total Interest Payable||406, 654||327, 810||254, 487|
|Saving vs 30 years tenure||0||76, 835||150, 158|
|*Assumption: 1.Loan Amount is 500k, 2.ELR used is 4.5%|
Do take note that when the loan tenure is shorten, you will need to pay a higher installment every month moving forward. However should BR or BLR drops in the future, you can opt to refinance to a shorter tenure by maintaining nearly the same monthly installments. This means that you pay the same as you have always been but you are still able to pay off your mortgage in a shorter period of time.
CASH OUT TO FINANCE A NEW PURCHASE OR OTHER NEEDS
Refinancing to cash out with the purpose of making a new property purchase is something, which needs thorough thinking. Though it sounds exciting cashing out from your property that has appreciated by 50%, do note that the cash out should be spent on assets, which will generate further income or appreciation.
The cash out from refinancing are often used on home improvement / renovation, which can tremendously, improves on the property that leads to a better market value on the property. There are homeowners who refinance with the purpose of child education, wedding funds, oversea dream trips, purchasing expensive goods such as furniture, fixtures, cars and etc.
In view that most of the banks in Malaysia do offer flexi-mortgage, if you decide to refinance your property with additional cash out and have no idea on what to do with the funds yet, leave it in your mortgage flexi account in order to save some interest. As such, you will have standby cash on hand without the need to pay additional interest on this cash until you utilize it.
Mortgage is the cheapest financing options in town as compared to overdraft, auto-loan/hire purchase, credit cards and personal loan. Refer table below on the financing rate comparison.
With regards to debt consolidation, refinancing would help if you have chalked up debts where their interest rates are relatively higher than of a mortgage loan. For example, a credit card charges with an effective rate of 15-18% and up to as high as 20% for a personal loan. Comparing to the mortgage interest rate of <5%, credit card and personal loan’s interest rates is like 3-4times more expensive. A savvy consumer, like yourself since you are reading this article now, will use the refinancing money to pay off the credit card or personal loan outstanding balance to enjoy potentially three times or up to four times interest savings.
|Mortgage||Overdraft||Auto Loan||Credit Card||Personal Loan|
|Effective Interest Rates(%)||4.4% - 5.0%||5.5% - 6.5%||5.5% - 6.5%||15% - 18%||15% - 20%|
CHANGING TO A DIFFERENT MORTGAGE TYPE
If you are having a variable rate loan (pegged against Base Rate (BR) or Base Lending Rate (BLR)) but anticipate that there will be major interest rate hikes (for instance higher OPR rate adjustment), it would be great to refinance your mortgage into a fixed rate loans now. This way, your monthly installment amount does not increase even if BR/BLR increases.
Conversely, converting from a fixed-rate loan to a variable rate loan can also be a sound financial strategy, particularly in a falling interest rate environment. If rates continue to fall, the periodic rate adjustments on BR or BLR will result in decreasing ELR and lower monthly mortgage payments, eliminating the need to refinance every time rates drop.
WHAT IS THE COST INVOLVED?
Before you take action in your home refinancing, there are a few items you would need to take note.
a) Moving Cost
This refers to money you would need to spend on in taking up a new loan. Items such as valuation fees, legal fees, disbursement and stamp duty is payable when you refinance. If you are refinancing to save on interest, take note of this amount and compare it against the savings in interest you would obtain through refinancing.
|Type of Cost||Cost|
|Property Valuation Fee||
Fees payable by the Land Administrator under the Land Acquisition Act for Valuation reports.
For property value greater than RM 1,000,000 the fee shall be minimum of RM 3,500 plus the fee based on the following rate
Fees payable by the Land Administrator under the Land Acquisition Act for Valuation reports.
|Loan Agreement Stamp Duty||RM 5 for every RM 1,000 loan amount (0.5% of loan)|
|Note: Some bank offer zero moving cost package, usually at higher interest rate. Compare this before you take up the loan.|
- b) Mortgage Lock-in Period
When you are ready to payoff your existing loan early (before the tenure expires), check if your existing loan has a lock-in period and if you are still bounded by it. Banks normally charge a penalty of 2% to 5% (on your original loan amount) if you fully pay off your mortgage within the first two to five years. This “two to five years” period, where you will incur a penalty for early settlement, is essentially the “lock-in period” of your mortgage.
SO HOW DOES ONE REFINANCE? WHAT IS THE PROCESS INVOLVED?
The process is quite similar, just like applying for a new mortgage. The steps to refinance your mortgage are as follow: (assuming you have identified your objectives of refinancing)
- Firstly check your current mortgage. Take note on your current mortgage whether it is still within the lock-in period.
- Contact a few banks to find out the deals that they are offering. The things need to be taken into consideration on this will be on the ELR, the moving cost, whether it is zero moving cost or partial moving cost are absorbed, and check if there is a lock-in period. Evaluate all these deals and which of them are important and align to your objectives set earlier. For example, if your intention is to cash out where funds may not be used now but later, getting a flexi loan but required to sacrifice to a longer lock-in period would be ideal. Only submit to the bank which meets your objectives.
- Always negotiate for a better ELR if you are not in a hurry to cash out. Then compare all your banks offer before deciding which to proceed.
- FINALLY, sign up and enjoy its benefits!
A COMMON MISCONCEPTION ON THE CASH OUT FROM A REFINANCING LOAN.
The debt service ratio of the additional cash out portion of your newly refinanced loan application will be calculated based on a 10 years repayment period. The portion used to pay off your existing mortgage will still be based on normal mortgage tenure, that is up to 35 years. But the above is merely the calculation affordability or debt service ratio. It has no impact to your actual refinanced mortgaged tenure. This is illustrated below:
Customer A has an existing mortgage of RM250,000 outstanding balances and refinances the said property with the market value of RM600,000 mortgage application. Then, the cash out amount, although your bank officer informs you that they would compute your repayment capacity based on 10 year tenure, it has no impact on your actual mortgage tenure and, most importantly, your monthly mortgage repayment. This is done to ensure that you have strong repayment capacity.
WHAT IS THE ALTERNATIVE BESIDES REFINANCING?
Top-Up loan will be the alternative. It is an additional loan on top of the current mortgage outstanding amount and it is based on the appreciated market value of the property. Some banks may open a new account for the additional top-up (i.e. 2 accounts to be serviced) while some banks may just top it up on the same account, which means to continue with the same account. Top-Up loan can only be done with the same bank from your original loan and most of the time, the bank will follow all the terms and conditions of the existing mortgage features.
The Pros & Cons of a top-up loan are explained below