Business

Saturday February 14, 2009

Making sense of mortgage refinancing

By CECILIA KOK


OVER the last three weeks, commercial banks in Malaysia have lowered their base lending rates (BLR), which are the minimum interest rates based on the cost of funds and other administrative costs incurred by the banks. This is in response to Bank Negara’s reduction last month of the overnight policy rate by 75 basis points.

Jeremy Tan

Currently, most commercial banks have their BLR pegged at 5.95%. This represents a reduction of as much as 80 basis points from the previous BLR of 6.75%.

As it is, existing home loan borrowers are already reaping the benefits of the new rates in the form of lower monthly repayments. The 80 basis point reduction in interest rate for a 20-year mortgage of RM100,000 has resulted in a savings of about RM50 per month or RM600 per year.

So, does it still make sense to refinance one’s mortgage – a process involving the application for a new loan to pay off the existing loan – when one is already benefiting from the new rates?

According to Jeremy Tan, a licensed financial adviser with Standard Financial Planner Sdn Bhd (SFP), the incentive to refinance lies in the current promotions offered by commercial banks.

These include attractive rates of as low as BLR minus 2.2%, and the elimination of “moving costs”, which comprise legal fees, stamp duties, land office and high court registration fees, among others.

Tan says: “Even with the moving costs, it is viable to refinance one’s mortgage so long as there is long-term interest savings to be derived.”

For instance, to a borrower with an existing mortgage rate pegged at BLR plus 0.75%, the current promotional rate of BLR minus 2.2% will translate into a savings of 2.95% on interest differential, or RM170 per month for every RM100,000 borrowed.

For a RM500,000 mortgage, this means a savings of RM10,200 per year or RM204,000 for 20 years.

On the other hand, MyFP Services Sdn Bhd financial planner and managing director Robert Foo sees the current downtrend in interest rates as an opportunity for one to lock in a lower fixed-rate loan, in which case, one does not have to worry about mortgage rates going up in the future when interest rates rebound.

Renovating portfolio

Generally, there are several factors that can induce a borrower to refinance. These include:

·to reduce interest payments with a new loan at a lower interest rate;

·to reduce monthly repayments via a new loan with a longer tenure period;

·to retire the mortgage earlier, and hence total interest cost, via a new loan with a shorter maturity period;

·to boost cashflow via a new loan with a higher amount than the outstanding owed under the previous loan; or

·to switch from a variable-rate to a fixed-rate loan.

Personal finance experts say it is important to manage a home mortgage well as it can have a major impact on the overall financial health of the borrower. This is because for most individuals, a property represents one of the biggest investments in his or her life.

So, before opting to refinance, they advise borrowers to do a break-even analysis between long-term savings and refinancing costs.

MyFP Services’ Foo says it only makes economic sense to refinance a mortgage if the costs of refinancing do not negate those long-term savings.

Tan of SFP concurs, adding that the refinancing costs could be exorbitant if there is a heavy penalty resulting from exiting a mortgage that is still under a moratorium period.

(The moratorium of a mortgage refers to a time period, during which the borrower cannot retire the loan. In the event the borrower initiates a full settlement of the loan during the moratorium period determined by the financial institution, a penalty fee of around 2% to 3% on the remaining loan balance will be imposed.)

Look before leaping

Financial advisers say refinancing may also be an unattractive option for a borrower whose mortgage has only a few more years left to maturity.

“The costs incurred for refinancing a mortgage in the latter years are relatively higher compared with the costs incurred if refinancing is done in the earlier years of the mortgage life,” Tan explains.

This is due to the fact that loan repayments during the early years of a mortgage are directed more to service the interest costs than to reduce the principal amount, and vice versa in the latter years.

Whether to refinance or not also boils down to an individual’s financial and life goals as well as his or her specific needs, financial experts say. For instance, one has to consider the impact of refinancing on the current and future cash flow, retirement plans and goals towards financial freedom.

Some financial pundits have said that refinancing could provide a lifeline to individuals who are cash-strapped, especially in times such as the current economic slowdown.

While refinancing can provide an alternative option to increase cash flow, Tan says the pertinent question to consider is what one is going to do with the extra liquidity.

He suggests that besides using the increase in cash flow to finance specific needs such as children’s education, an individual should also consider investing the additional cash in instruments that can either “create wealth” immediately or increase one’s net worth in the future.

Early loan retirement

On the other hand, when it comes to refinancing a property with a mortgage that has already been fully settled, one has to bear in mind that the refinancing amount, mortgage tenure and monthly repayment amounts are dependent on one’s current age to retirement and capacity to repay.

“The capacity to repay is crucial as there must be a certainty or guaranteed repayment to prevent jeopardising the mortgaged property in the future,” Tan explains.

For an individual who is near retirement age, refinancing may not be a good option, as it is wiser to retire the existing mortgage (if there is one) earlier and be free from liabilities, financial experts say. The exception is if the individual is certain that the money raised through refinancing can be used to generate returns that are higher than the cost of borrowing.

“Otherwise, it will affect the individual’s cashflow and reduce the monies that one has set aside to outlive his or her lifespan,” Tan explains. Another area that a borrower needs to consider is how refinancing can affect the insurance coverage taken for a mortgage.

Usually, when refinancing is initiated, the bank refinancing the mortgage will require the purchase of a new fire insurance policy – a mandatory cover for any mortgage - with its panel of insurers.

In the case of the mortgage reducing term assurance (MRTA), the bank may not necessarily insist on a new policy as the existing policy can be reassigned. A new policy will only be required if the refinancing amount is higher than the outstanding amount of the existing MRTA coverage.

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