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Saturday, December 12, 2009

What’s the buzz on home loan refinancing?

Why would anyone want to refinance his home loan? The base lending rate (BLR) has been reducing over the past 10 years. From about 8% in early 1999, it has come down to about 5.5% currently (for most of the banks, as Bank Negara allows banks to determine their own BLRs).

Therefore, if you took a home financing package some time ago, you are paying more interest as compared with a person taking the same loan today.

That is only half of the story. Loans taken in early 2004, for example, came with a BLR + 0.25% rate. More recently, the rates are BLR minus 1.8 to 2.4%. To show the variance in the interest payments, let’s use an example with the recent average rate of BLR minus 2%.

We compare a loan signed in 2004, with an outstanding balance of RM100,000, against a new loan of RM100,000, with the following scenarios:

·BLR in 2004 : 6.75% (Therefore loan interest is 6.75% + 0.25% = 7%)

·BLR in 2009: 5.55% (Therefore loan interest is 5.55% - 2.0% = 3.55%)

So the loan taken in 2004 would result in an annual interest cost of RM7,000 (RM100,000 X 7%), whereas interest on the taken during recent times cost would be RM3,550 (RM100,000 X 3.55%).

The difference is a whopping 49%, and the annual saving is RM3,450. For loans of RM300,000 and RM500,000, the amounts saved work out to RM10,350 and RM17,250 respectively.

Therefore, looking squarely at interest cost, there is tremendous savings to be achieved by refinancing your home loans today.

However, one must also be aware of the “lock-in” periods usually provided for in loan agreements, whereby banks specify minimum loan holding period (ranging from three to five years).

Therefore, an early settlement of the loan will result in a penalty payment, usually a percentage (ranging from 2% to 5%) of the loan amount.

Another element of refinancing is that the bank that provides the refinancing usually absorbs the transaction costs such as legal fees.

You can also turn to refinancing to lengthen or shorten your loan tenor, depending on your priorities. For example, you can increase your loan tenor so that your monthly loan repayment is lower. Others cut their repayment periods, therefore opting for higher instalments and less total interest cost.

Yet another reason for refinancing is to realise the cash value when the property that has appreciated significantly. Otherwise, the only way to benefit from the capital appreciation is by selling the property.

Refinancing makes it possible to realise up to 90% of the property’s current market value. Let’s assume a 100% home financing loan at RM100,000 as an example.

If the property has appreciated 20%, the value today would be RM120,000. As such, one can refinance at RM108,000 (90% of RM120,000).

If the RM100,000 loan was taken in 2004 on a tenor of about 15 years, the outstanding balance would be about RM77,000. The refinancing of RM108,000 will result in a cash-in value of RM31,000, which can be used to retire high-cost borrowings (such as credit card balances) or to invest for higher returns.

Here is the interesting part. For the higher new loan, the interest per annum works out to about RM3,800 (RM108,000 X 3.55% = RM3,834). This is still lower than the interest payable on the existing loan balance of RM77,000, which is about RM5,400 (RM77,000 X 7% = RM5,390).

With the refinancing, interest cost is slashed, instalment is lowered (assuming continued loan tenor with no increase), and you get RM31,000 cash in hand. Now, isn’t that just a clever idea!

A point to note is that while you qualified for the initial loan, refinancing is not an automatic option. The financial institutions will check your credit worthiness and will want supporting documents to show payment capabilities. Therefore do maintain a sound financial status. Never allow overdue payments to exceed two to three months and verify your credit status.

It pays for the borrower to walk up to his banker and request for a loan restructuring, especially when the loan is still within the lock-in period. Banks are known to be willing to listen and accede to restructuring requests, albeit resulting in a longer lock-in period.

This works out well as both parties’ interests are served. I propose this option first.

Financial institutions have been on the prowl for refinancing, with a foreign bank advertising with this tagline: “Refinance with us and earn a free flying lesson.”

Why not? Happy refinancing.

Raymond Roy Tiruchelvam is a former senior manager – economics and investment analysis at an oil and gas outfit.

By The Star (by Raymond Roy Tiruchelvam)

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