We’ve talked about home loan refinancing many times in over the past few months. There’s a good reason for that – with interest rates looking set to remain at all-time lows for at least a couple of years, there has never been a better time to refinance. You can bring down your monthly instalments, conserve your cash flow, and enjoy more financial breathing room – all especially important in the time of COVID-19.
All these benefits come from refinancing at a lower rate, plus a possible extension of your loan tenure. But what about the opposite – refinancing at a lower rate, but this time with a shortening of your tenure? This will drive your monthly instalments up, put more strain on your cash flow, and constrict your financial breathing space.
Why would anyone want to do that?
Well, it can actually make perfect sense for those who can afford higher instalments, want to save on interest costs, and whose priorities are focused on clearing their mortgage debt.
3 Reasons You May Want to Refinance with A Shorter Tenure
Reason #1: You Want to Save 5 to 6-Figures in Interest Costs
How much could you save in interest costs by refinancing at a lower rate into a shorter tenure? Let’s look at two refinanced home loan tenures, with the same amount and interest rate. The only difference is for the first one, the refinancing tenure is 20 years and the second is at 10 years.
Amount
$500,000
$500,000
Interest Rate
1.8%
1.8%
Tenure
20 years
10 years
Estimated Monthly Instalments
$2,482
$4,556
Interest Costs Over Loan Tenure
$95,759
$46,723
Interest Costs Savings
$49,036
$49,036
As you can see, shaving 10 years off a 1.8% $500,000 loan could save you almost $50,000 in interest costs – a substantial sum. Of course, as we said, you must be able to bear significantly higher monthly instalments. But the interest savings are very real.
See for yourself: Use our easy Mortgage Repayment Calculator to see how much you could save in total interest costs.
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Further, this is a simplified example that doesn’t take into account future interest rate increases. Remember, right now, interest rates have never been lower. But for us to expect it to remain that way for decades is unrealistic. Even over a 10-year period, it is reasonable to expect higher interest rates toward the latter half.
So, for example, if low interest rates persist for another 5 years, that’s half of the 10-year loan tenure – but only a quarter of the 20-year tenure. Once you take this into account, the interest savings on a $500,000 home loan would actually be significantly more than $50,000.
Finally, don’t forget that by refinancing into a lower rate, you are already saving on interest costs. This can help offset some of the higher instalments from a shorter tenure. For example, for a $500,000 mortgage, lowering the interest rate from 3.3% to 1.8% (the amount SIBOR has fallen from the beginning of 2020 to October), can already save you about $350 per month.
Of course, that offset is relatively small compared to the increase in monthly instalments you would have to bear from shortening the loan tenure. This brings us to the second reason, which is…
Reason #2: You Can Afford the Higher Instalments
Can I afford the higher instalments that come with a shorter loan tenure? When asking yourself this, there are two components – regulatory and personal.
The regulatory component is your Total Debt Service Ratio (TDSR). Under MAS rules, your total debt repayments cannot exceed 60% of your income. This is a hard line that will tell you the maximum you can shorten your loan tenure.
The second is the personal component. This is far more subjective. But some questions to ask yourself would be:
Do I have any other higher-interest debt? (Pretty much all other types of debt would be higher interest than your home loan)
How many months of expenses do I have in my emergency fund?
How stable is my income? Do I expect it to increase over the coming years?
How do I foresee my expenses growing over the coming years? Do I expect it to grow faster than my income? (Don’t forget to account for “big expenses” like higher education, weddings etc.)
MAS regulations aside, only you will know whether you can afford the higher instalments. These questions are just there to serve as guidance. But there is also one more personal question you should ask yourself – what are my priorities?
Reason #3: Your Top Priority is Being Debt-Free
If you go to an investing forum and ask them whether you should shorten your loan tenure via refinancing, there is a good chance they would laugh at you. They might say something like:
Why pay such high monthly instalments when interest rates are so low? If you can afford the higher payments, you might as well take the extra money and make it work for you in the markets! As long as you can make a return on your investment that exceeds your home loan rate, you will still profit. It’s silly to be overly focused on paying down such low interest debt, given the opportunity costs.
And you know what? They aren’t wrong. In fact, their argument is perfectly rational. But it misses something very important – the personal part of personal finance.
Everyone has different priorities. For those who would frequent an investing forum, their priority is most likely achieving returns. So, it would not make sense for them to pay extra to shorten their home loan tenure. In their minds, they can easily make far more by investing than what they would save in interest costs. They are thinking offense.
Others may prefer defence. They want to limit their downside as much as possible, so their top priority is becoming 100% debt-free as fast as possible. And they don’t mind giving up potential returns to do so. They know themselves well enough that they are certain that being debt-free is what will make them the most psychologically comfortable.
Neither is wrong – it’s all personal. So, some introspection is necessary here. If you have done the math and know you have the financial means to service the higher instalments, ask yourself – which is best suited to my personality and psychology?
Which is the Right Choice for You?
Truthfully, we cannot answer this question for you. We’ve shown you the math and we’ve laid out the guidelines. Without knowing you personally, we can never definitely say one way or the other.
But if you’d like, we can take it one level deeper. If you are still debating whether this is the right choice for you – or if you have any other questions about home loans or refinancing – then just go to this page and fill out a short form. And within 3 hours, one of our friendly and professional Home Finance Advisors will get in touch to offer you advice personalised to your situation.
If you’d rather browse around a little more first, then please check out our extensive Home Financing Guides.
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