The amount of cash you must fork out each month in instalments for your home loan is mainly determined by the interest rate on your home loan (as well as the loan tenure). So, it’s no surprise that most property owners would jump at the chance to refinance when interest rates fall.
With the coronavirus pandemic having depressed global interest rates – dragging Singaporean mortgage rates down to the 1.4—1.8% range – banks are getting more refinancing inquiries and applications than ever. And since you’re reading this article, there’s a good chance you’re wondering whether you should leap on this refinancing opportunity yourself.
If that’s the case, then there’s one question you should be asking yourself:
Are Interest Rates the Only Consideration When Deciding Whether to Refinance?
If you answered ‘yes’, then you’re only seeing half the picture – which could be detrimental to your financial health. The missing half is cash flow, and it is crucial you understand why and how you must think about it when making a refinancing decision.
Now, just to make things clear, we are not saying you should (or shouldn’t) refinance. All we’re saying is that cash flow is just as important as interest rates when assessing whether refinancing is right for your individual situation.
Here is Paul Wee, Managing Director at PropertyGuru, explaining how to view the issue:
But wait, you might be thinking. Don’t lower interest rates equal lower monthly instalments, which results in improved cash flow? Aren’t they then really the same thing?
The answer is yes – but also no. Yes, it is true that refinancing at a lower interest rate usually means lower monthly instalments. But no, although they are related, they are not the same thing at all. And in this article, we will explain why. Specifically, we will explain:
- Why you need to ensure you have cash “on hand” before refinancing
- Why you should prioritise your emergency fund especially in times of uncertainty
- Why you should consider extending your home loan tenure
Make Sure You Have Cash “On Hand” Before Refinancing
While refinancing can indeed save you money, you should remember that refinancing comes with its upfront – and sometimes hidden – costs. Here are two of the most common upfront costs associated with refinancing. While the first one is unavoidable, the second one is not.
- Conveyancing and valuation fees – typically ranging from S$2,000 to S$3,000
- Prepayment penalties – applicable if you are still within the lock-in period of your home loan. This could cost 1—5% of the outstanding loan amount, which could severely strain your cash reserves
It’s true that over the long term, the savings you would get from lower monthly instalments is almost certain to more than compensate for these costs. But you must still factor these in your initial cash flow calculations as well.
You can use PropertyGuru’s handy Home Loan Refinancing Calculator to find out how much you might save on your monthly instalments if you refinance, and see whether it’s worth it after factoring in all the costs.
But even if it does make financial sense, remember that home loans are a long-term game, which means that you should…
Prioritise Your Emergency Fund to Give Yourself a “Safety Net”
We’ve already seen how many businesses worldwide have shuttered simply because they did not have enough cash on hand to maintain expenses for even a few months without incoming revenue. The analogy from a personal perspective is losing your job. Although the situation in Singapore has somewhat recovered, it would be irresponsible to act as if the whole thing has blown over.
And when uncertainty is high – as it is now – a bird in the hand is worth much more than two in the bush. This means that you should strongly consider placing building a robust emergency fund as a top financial priority.
Many experts have thus increased their recommendations for how much you should keep in your emergency fund. For example, personal finance guru and bestselling-author Ramit Sethi now recommends creating an emergency fund with at least one year of expenses.
If you don’t already have this – or if you think that your situation will not allow you to build up this amount anytime soon – then a refinancing might be able to help. The additional monthly savings you would get from lower interest payments and a longer tenure can be diverted towards your emergency fund.
Should You Extend Your Home Loan Tenure?
In addition to securing more attractive interest rates, refinancing also gives you the chance to extend your home loan tenure (depending on your original tenure). Intuitively, many homeowners avoid this because it means higher interest costs. While that is true, extending your tenure is a huge positive from a cash flow perspective.
Yes, a longer tenure means paying interest for a longer period, hence incurring higher interest costs in the long run. However, although a shorter tenure means less interest paid, your monthly repayment (i.e. cash flow commitment) is higher.
This is all fine and dandy when things are going well, but what about in the event of unfortunate circumstances? As mentioned above, an emergency fund is extremely important, and with high cash flow commitments, building that safety net is much harder.
We’re not saying you should always stretch out your tenure – we’re just saying don’t knock the idea. Even though it does cost more, for many, extending the tenure can be very helpful. After all, flexibility is key when managing your mortgage.
Moreover, there are many more strategies (like partial repayment) to manage interest costs as opposed to freeing up immediate cash during times of need.
Every case is unique, and your personal cash flow situation will play a big factor in what the best choice is for you.
And although you may end up paying more in interest over decades, cash in your hand now may be more valuable than cash in your hand years later. If you have a private property, another option you may want to consider is a cash-out refinancing or home equity loan. This can also be a good way to pay off higher-interest debt and provide further relief to your monthly cash outlay.
Balancing Interest Rates and Cash Flow – One Size Does Not Fit All
The challenge with balancing both interest rates and cash flow is that one factor applies to everybody, while the other applies only to you. And while at PropertyGuru, we can unequivocally say that the current low interest rate environment presents a fantastic opportunity to refinance, we want to make sure you don’t neglect to consider your personal cash flow situation in the process.
We hope that this guide has given you more to think about when it comes to making important refinancing decisions. If you think that refinancing makes sense to you, be sure to check out our Ultimate Refinancing Checklist.
If you need more help and are looking for advice personalised to your situation, we invite you to speak to one of our Home Finance Advisors for an independent and unbiased viewpoint. And for any information you need related to home financing, please look through our home financing guides.Chat with us on Whatsapp Fill up an online form
This article was written by Ian Lee, an ex-banker turned financial writer who hopes to use his financial background and writing skills to help raise people’s financial literacy levels – a necessity in our modern world.
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