lock in period prepayment penalty and loan restrictions

The Perils Of Lock-In

Everyone is familiar with the concept of a lock-in or a contractual period with the most ubiquitous being that of a mobile phone plan’s 2-year recontract period whenever one upgrades his or her iphone in Singapore.  The penalty for breaking such a mobile phone contract is to pay back the telco a certain amount of subsidy given on the new iphone sold to you earlier at a “subsidized” or promotional price.

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When it comes to home loans, this penalty amount to be paid back if one breaks his mortgage contract is not merely a few hundred dollars but huge – at 1.5% of the outstanding loan!  Take a typical loan for a private property in Singapore at $700,000, this means paying back $10.500!  Surely a showstopper for anyone thinking of refinancing out to another bank to save on interest costs.

It is hence interesting that we observe in the past few years that most homeowners in Singpoare are not too particular about lock-in periods that is tied to most home loan packages today (usually 2 years sometimes longer).  Most would gladly sign on the dotted line for a floating rate home loan without raising an eyebrow, especially when lured by lower nominal headline rates in the first few years.

When SIBOR starts to climb more aggressively since the start of the year, and hiking of mortgage pegs by various lenders becomes more commonplace, the reality of lock-in penalty begins to bite.  Most banks have adjusted up their mortgage pegs by 0.30% to 0.60% this year, and most homeowners on floating rate packages have found their interest rate suddenly going up to above 2%, some with barely less than a year into their 2-year lock-in period.  What this means is that one would be unable to refinance out, or even negotiate with their existing bank to reprice to another lower-rate package while they are still locked in.  The lock-in means the borrower is essentially trading off his right to quit or break the contract in return for lower promotional rates.  This trade-off then has got to makes sense with a wide enough discount from prevailing floating rates if one is to sign away his rights to walk away.

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The good news is, unknown to some homeowners who simply reprice with their banks, there are actually interesting home loan features offered by a few lenders out there that mitigate the restrictions of a lock-in period.   With interest rate expected to continue on its upward trajectory, homeowners ought to look beyond interest rate per se and start exploring many other mortgage loan features available in the market place.

 

No Penalty For Partial Repayment

There are many clients we know with high balances in their CPF Ordinary account which they leave behind to earn the risk-free compounding interest of 2.5% p.a. while they use cash to service their monthly repayments.  When interest rate starts to rise up eventually above 2.5%, it would make perfect sense to deleverage and pay down part of the mortgage, be it using cash or CPF.

There are home loan packages that allow one to prepay partially up to any amount during the lock-in period, leaving behind just $200,000 outstanding loan, sometimes even leaving nothing but $10,000 balance in order to redeem the loan in full after the 2-year lock-in period so as to avoid any penalty.

 

No Penalty For Full Redemption Due To Sale Of Property

Yet there are more than a few banks now that offer full waiver of penalty when the redemption of loan is due to sale of property during the lock-in period.  And the best part – this applies even to fixed rate home loan.

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It is no longer true that if one has intention to sell his property soon, or when his condo is going through an enbloc exercise, it will be unwise for him to refinance or reprice to a fixed rate home loan to lock down runaway interest costs should he take much longer to complete the sale.  It used to be true as even repricing to another home loan package often comes with a fresh 2-year lock-in period and he will need to pay 1.5% penalty on the full loan upon completion of sale.  Now, the best thing to do is simply refinance to another bank that offers this full waiver feature due to sale of property.  That way, the worst-case scenario would be simply to refund back to the bank the legal subsidy of $1800-$2000 should he manage to sell his property in the next 3 years (legal fee clawback period).  That is a far cry from paying 1.50% penalty on the outstanding loan.

 

Free Conversion If Bank Increases The Mortgage Peg

Again, there are more than a few banks offering this feature which gives homeowners some kind of bargaining chip.  To allay fears of being “trapped” in a particular floating rate package for 2 years where the lender would then mercilessly jack up the mortgage peg couple of times in a year, banks now dangle the right to request for a free conversion anytime should the mortgage peg be raised.  This essentially means that homeowner could ask to reprice to another better prevailing package with the bank (usually they would opt for fixed rate in such a scenario) and the bank would do that free of charge without slapping the usual admin fee for repricing.  In a way, this puts a restraint on lenders who might otherwise raise interest rate with no fear of exodus of clientele base or mass switching of home loans to lower-spread packages within the bank.

 

In fact, as the gap now between the lowest floating rate home loan at 1.70% and the lowest fixed rate home loan is at 1.68-1.85%, why get locked in for 2 years on a floating rate when one could effectively eliminate all the perils of lock-in period by signing on a fixed rate?  Speak to our consultants today to find out more.

 

Since 2014, MortgageWise.sg has provided thought leadership in the mortgage planning space in Singapore, taking deep dives into the latest developments in the industry, providing useful mortgage tips, and making sense of rate movements.  We seek to build trust with clients over the longer term instead of doing product-peddling for quick one-time deals.  That’s why we always present “whole-of-market” perspective including home loan packages that some banks do not pay us.  Read our clients’ testimonials.

 

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About Darren Goh

Darren Goh is the Executive Director and founder of MortgageWise.sg, and a thought leader in the Singapore mortgage industry with frequent interviews by the press Business Times, Straits Times, Zaobao and EdgeProperty for his views and analysis on the latest mortgage trends. His article has also been published in The New Paper (formerly TodayOnline). He started his career in consumer banking product development for 6 years, before moving on to an illustrious 10 years sales career in marketing luxury real estate (Ardmore Park) where he set the record sale price (still) of $10.64m and run his own successful boutique agency as KEO. He now combines his knowledge in both financial services and real estate investment to advise clients on mortgage solutions.
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