With interest rate staying elevated, more homeowners are looking to pay down their mortgage loan during refinancing. Is that the best course of action to take?
Since amortization, or P (principal) plus I (interest), is essentially a play on four variables, there are four known ways to cut your mortgage interest of which paying down on the outstanding loan is one. There are other ways where the benefits may be less obvious but they can be equally effective if not more. We will look at them one by one.
Lowest Fixed 3.05% (Min $500k)
1. Interest Rate
This is what most homeowners focus on especially the headline rate in the first two years. That’s how most will base on their final decision on when choosing home loan packages. Some will look at how much vouchers or free gifts they could wrangle from the bank or the broker. Others reckon that it’s too much trouble for that little bit of difference in the headline rate and decide to forgo the savings and simply reprice (recontract with the current bank) to avoid all the work. Being in the industry for coming to a decade and with good hindsight of how things played out for most from 2014 to 2023, this is what we have to say:
It’s not how much you pay now, but how much you could be paying a year or even a few months from now, which makes the most significant difference to your savings.
To give you an analogy, it’s like negotiating to buy a condo and giving in to seller’s demand for $1,500 psf instead of holding out your offer at $1,450 psf. Two years later, that decision could fetch handsome profits when market valuation rises to $1,800 psf. Conversely, there are times when you may gloat over a small win at $1,450 psf instead of paying up but only to find yourself in negative equity when the broad market nosedives to $1,200 psf. Getting it right in big cycle moves is a much bigger win than in small price negotiations. In a similar fashion, we see some homeowners seduced by lower headline floating rates at 1 per cent at the start of 2022 instead of paying up for fixed rates at 1.25 per cent and live to regret that. Fast forward a year later to 1H of 2023, again we see homeowners scrambling to commit to 2-year fixed rates at 3.80 to 4 per cent, against our advice. Within a span of six months, fixed rates have now tumbled to 3.05 per cent for home loans above $500,000, even going below 2.95 per cent for bigger loans.
What’s the sure-fire way to save on interest? Don’t just focus on the headline rate and choose the lowest number. Overcommitting to a mortgage has turned out to be the single most costly mistake for many in the cycle-turning years of 2022 and 2023 which will continue into 2024. Macro-economic environment can change very quickly, sometimes overnight like the threat of a war spilling over to affect global economy beyond just a geographical region. Above all, work with a professional mortgage broker with the track record who can guide you on how best to position your mortgages both in a up and a down cycle which ultimately saves you the most.
2. Principal Sum
To cut interest cost, the most obvious course of action to take here is to pay down on the outstanding loan. Indeed, as highlighted earlier, we have seen an increase in the number of such requests during refinancing this year. What’s lesser known is the opportunity cost for deploying such cash on hand for paying down debt. And I am not alluding to seeking out investments like S-REITs which can pay good dividends of 6-7 per cent based on today’s beaten down prices, albeit that makes a lot of financial sense especially when mortgage interest has dropped to 3 per cent. I am not referring to REITs or other investment asset classes which carry risk, but some other clever ways of using your funds where you can generate cash flow without much risk, to bring down some of your monthly commitments. Look for the next upcoming article in which I will discuss in depth one of those clever ways.
For HDB homeowners, you have to think twice before paying down as there’s no way for you to cash out again other than selling the property, which is penny wise pound foolish if you have to sell out for $600,000 just to unlock $100,000 that you need. Even for private property owners, many are surprised to learn later how hard it is to cash out on their property when applying for equity term loan as regulatory limits like TDSR and stress test interest had been tightened. And that’s provided you still have the same or higher income to apply for the term loan, which may be the exact reason why you are doing so.
Perhaps a good alternative here is to apply for a mortgage interest offset account which has the same effect as paying down without actually paying down. This is a current account which pays you the same deposit interest rate as your mortgage interest, up to typically two-third of the funds you deposit in the account. This means you have the flexibility to withdraw the funds as and when needed, or put it back anytime so that the interest component of the mortgage gets “offset” by the deposit interest hence more of your monthly repayment goes to reducing the principal outstanding.
Lowest Fixed 3.05% (Min $500k)
What’s the sure-fire way to save on interest? Don’t just focus on the headline rate and choose the lowest number. Overcommitting to a mortgage has turned out to be the single most costly mistake for many in the cycle-turning years of 2022 and 2023 which will continue into 2024.
This is more an idea to cut the monthly repayment rather than interest. Most homeowners baulk at the idea of stretching out their loan tenure over a longer period (subject to both age and regulatory limits) as it means paying more interest. In reality, most people will move house within 10 years and redeem the loan prematurely. Of course, some will argue that you would have paid the bulk of the interest in the first 10 years of the loan. Let’s look at a simple case study of stretching the loan tenure from 20 years to 30 years on an outstanding mortgage balance of $800,000. As interest will rise and fall, we will use a long run average rate of 2.5 per cent and look at the total interests paid in the first 10 years.
Case 1: $800,000 over 20 years
Monthly repayment = $4,239
Total paid in 10 years = $508,707
– interest component = $158,395
– principal reduction = $350,311
Case 2: $800,000 over 30 years
Monthly repayment = $3,161
Total paid in 10 years = $379,316
– interest cost = $175,834
– principal reduction = $203,482
Indeed, you are paying more interest in the first 10 years with all else held constant. How much more? $17,439 ($175,834 – $158.395). You can see this is about a year’s interest you are paying right now on a 20 years’ tenure. In short, you are paying about an extra year of interest to the bank over the next 10 years by stretching the tenure and bringing your monthly repayment down by about $1,000 every month ($4,239 to $3,161). You cut the monthly repayment, but not the interest.
So, does this make financial sense? Ceteris paribus, you can see the bigger impact of a shorter loan tenure is not so much on saving a year’s interest, but how you can reduce the outstanding loan quite significantly by $350,311 in the first 10 years, instead of $203,482 (if you lengthen the tenure). That’s paying down your debt by more than 70%! You end up with an outstanding loan of $449,690 instead of $596,518 after 10 years. However, that $1,000 cash flow per month you save on paying mortgages means you have a sum total of $120,000 over the next 10 years which you can now divert to other purposes or investments which could yield you even higher return like what we discussed earlier. That’s what you are paying for with that extra year of interest to the bank. Even if you have no intention to re-channel it elsewhere for investment, you still retain the option of using it to pay down on the mortgage later.
In other words, you wouldn’t lose out much in terms of capital repayment by stretching out your loan tenure, other than an extra year of interest to the bank. The next idea will show you how you could recoup that cost. The upshot is you don’t necessarily need to suffer much loss in stretching your tenure.
4. Monthly Instalment
Can you still save on paying the monthly instalment after pursuing some or all of the above suggestions? The answer is yes. How about shaving off another $50-100 per month by simply refinancing out to another bank whenever you are out of a lock-in and clawback period (the latter refers to a typical 3-year period in most contracts when you will be asked to return the legal subsidy should you leave early)? You may think that’s too little for too much work. But let me show you how this is equivalent to almost an entire year of mortgage interest saved!
From our experience, with free market competition, there’s almost always another bank that could offer you at least a 0.2 per cent difference in total interest savings over a 3-year period! The problem is most homeowners underestimate that savings and simply choose the easy way out by repricing and staying put with their current bank. On a typical loan of $800,000 that’s $1,600 saved. And if you add all the excess cash rebate that’s often included, we estimate the average savings when you refinance is more like $2,000. Depending on whether you average this amount over three or four years (due to clawback), that’s how you can shave off at least $50 a month from your monthly instalment, or more for bigger loans.
We estimate that you will have opportunity to refinance at least 6 to 8 times over a 30-year loan tenure, if you seize every opportunity to do so in order to profit from free market. Just don’t sit back and think a 0.2 per cent difference, i.e. around 0.05 per cent savings per year, is too little for too much work. It adds up to almost $14,000 (7 x $2,000 per refinancing) or almost a year’s worth of interest saved.
For HDB homeowners, you have to think twice before paying down as there’s no way for you to cash out again other than selling the property, which is penny wise pound foolish if you have to sell out for $600,000 just to unlock $100,000 that you need.
Need more advice? We don’t just throw you a set of rates, or get different bankers to sell to you. Not only do we help clients navigate through Singapore mortgage rates quick and fuss-free, we show you how best to position and profit from the interest rate cycle, be it for residential or commercial property loan. Work with us today and you’ll also be helping to support our social cause!
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Lowest Fixed 3.05% (Min $500k)
Disclaimer: MortgageWise.sg endeavours to bring the best insights and knowledge in our expert domain of mortgage planning to the market. Still, all viewpoints expressed in our blog remain as opinions of the writer, and shall not be constituted as financial advice. We cannot be held responsible in any way for any financial losses arising from your mortgage decisions should you choose to rely on any of our viewpoints and opinions.