Refinancing your mortgage is the process of taking a second home loan to pay off the first one; this is usually done after you have had the initial loan for a few years, and want to reduce your monthly payments. This can be possible due to two factors. If lending rates have gone down, a home loan can be taken from the bank at a cheaper rate. Secondly, by extending the life of the loan, the equal monthly installments are also reduced.
How much you can save with a home loan refinancing depends on the amount borrowed and the interest rate. For example, if a borrower has taken a 25 year mortgage for AED 1 million at an annual rate of 4.5%, the monthly payments equate to AED 5,558. Suppose after 5 years, interest rates have gone down and the borrower can refinance at a rate of 3.5%. A portion of the initial loan amount has been paid off already, and only AED 878,579 remains. If the borrower refinances with a new 25 year home loan at an annual interest rate of 3.5%, the new equal monthly installment decreases to AED 4,398. Approximately 58% of the savings come from extending the life of the mortgage for another 5 years, while 42% of the reduction in payments results from the decrease in the home loan interest rate to 3.5%.
Is refinancing the right tool for you? Keep in mind that you will have to pay early repayment fees to your old bank (over 1% of the loan amount), in addition to application, property valuation and arrangement fees to the new bank. So if you are planning on selling your property within the next few years, then you should reconsider any plans for refinancing.
If your property has greatly depreciated in value since the original mortgage was taken out, and the loan amount outstanding is more than what the property is worth today, it will be virtually impossible to find a bank that is willing to refinance your home loan.
Lastly, here in the UAE, the interest rate on most home loans is fixed for up to 5 years. After this period, you will be subject to a variable rate, which typically moves in the same direction as interest rates in the UAE. For this reason, if a substantial amount of time has elapsed since the original mortgage was taken out, say 12 years into a 25 year mortgage, you are almost half way to fully owning a home with no debt payments. So unless the numbers add up for a refinancing, it could be wiser to just wait out the remaining time.
With Al Etihad Credit Bureau set to provide credit analysis about all consumers in the market, it is important not commit any mistakes that could negatively impact a credit report. As banks turn to these reports to deem if consumers are credit worthy, any blemish on one’s record could hurt a refinancing applicant’s chances or even warrant a higher interest rate to compensate for the poor credit profile.