Many of us have heard this term when we purchase our first home but do you know what it really means?
According to iMoney, home loan refinancing involves taking a new home loan to replace the existing home loan. This means the first loan is paid off and a second loan is created.
There are many reasons for homeowners to refinance:
- the opportunity to obtain a lower interest rate
- the chance to shorten the term of their mortgage
- to convert from adjustable-rate mortgage to a fixed-rate mortgage or vice-versa
- the opportunity to tap a home’s equity in order to finance a large purchase or getting the cash flow
- the desire to consolidate debt
Advantages of Refinancing
Low interest to obtain cash flow
Refinancing is a way that allows an individual to obtain cash for large purchases such as cars or to reduce other debts. This is known as a cash-out refinance because the borrower refinances for more than the amount they still owe the bank and takes the difference in cash. How is it that they are able to refinance for a high amount of loan? Over the years, if times are bullish, the property’s value will appraise. The bank will evaluate the current value of the property and determine how much they are willing to loan. Then the some of the total sum of the loan is used to pay off the original loan, while the remaining money can be cashed out.
Here’s a simple example to illustrate the idea. If you bought a property at RM250,000 a few years ago and you still owe the bank RM175,000 today. However, the property now is worth RM400,000. So, if you were to refinance and apply for an 80% loan at the property’s market value, you will get a loan of RM320,000. After paying off the original loan, the remaining RM145,000 can be cash out. This is just an example to illustrate the idea, the actual number might be different depending on the interest rate and loan packages.
Lower interest loan packages or shorter term
Another reason people choose to refinance their home loan is to get lower interest loan packages. The housing loan interest rate is not fixed. So there might be a time when the market interest rate is lower than your mortgage’s interest rate. A lower interest translates to lower monthly payments, which means you’ll pay less for your home overall. With that said, it will allow you to have extra cash in your budget for your investment or saving purpose. Often you can get a better package with promotion or cash back rewards while refinancing your loan package with another bank.
Besides that, you can also choose to shorten your loan term by refinancing. From the time you bought the home, you might have been promoted in your career and might more cash flow each month. So you will definitely want to shorten your loan term and pay off it faster. By refinancing, you are able to get better loan packages with a shorter term and better loan interest as compared with your previous one.
What to avoid when refinancing your home loan
One thing that you need to take note before proceeding to refinance a home loan, is the prepayment penalty. Some banks may have a lock-in period for the loan. If the borrowers wanted to pay off the loan before the lock-in period, there will be a prepayment penalty. Thus, before you decide to refinance your home loan, check the clauses in the loan contract first. If there is a lock-in period and prepayment penalty, calculate first to ensure that even after you pay off the penalty, it will still be worthwhile.
Extra cost and processing fees
Another thing to take note is the extra cost and processing fees. Those costs include the bank processing fees, stamp duty, legal fees and property valuation fees. Thus, those who want to refinance their home loan need to take those costs into consideration first to determine whether it is worth it or not.
Refinancing a home loan can be a great financial move. However, only if it can reduce your mortgage payment, shorten the terms of your loan or help you build equity more quickly. However, you have to understand your financial situation and what the results you want to achieve with refinancing. If you don’t understand or are confused about home loan refinancing, you should seek a consultant for professional advice. It might cost you some fees upfront but it will always save you from making bad decisions.