Case Study: Why You Should Refinance even with Penalty

Today, we are going to do a case study of a real story. Mr.Tan (of course not his real name) took up a home loan from Alliance Bank. Nowadays, the home loan package offer is irresistible. I met Mr. Tan and we discussed about this matter whether should he refinance his mortgage. He will have to pay the early settlement penalty if he do it this year. He wants to know would it be advisable to refinance his home loan now to seize the all time low interest rate opportunity recently.

Let’s look at his present situation and his existing home loan:

• Loan provider: Alliance Bank
• Original loan amount: RM190,711.10
• Current interest rate at 2nd year: BLR +0% = 6.75%
• Installment: RM1243/month
• Outstanding loan: RM160,498.80
• Remaining tenure: 29 years
• Penalty for early settlement: 3% of original loan amount or RM5,000 whichever higher = RM190,711.10 x 3% = RM5721.33

Image: Existing home loan interest schedule

So I do an analysis what would happen if he refinances his mortgage to OCBC bank.

Image: OCBC home loan offer

He thinks that BLR will most like falls in the future. So he opt for the variable interest offer with zero moving cost. Zero moving cost means the bank will pay for all the loan agreement, stamp duty and also the property valuation fees.
So here is the package he will get

• Year 1-5: BLR – 1.4% = 5.35%
• Thereafter: BLR – 1.55 = 5.20%

Let’s assume BLR stay the same at 6.75% for easy calculation. Anyway, the BLR rate is pretty standard.
Mr.Tan doesn’t want to pay any extra amount for the refinancing process. He just wants to continue his installment monthly as usual. Thus, I said it is better to finance his penalty of early redemption by including it in the new home loan application. So he can choose to finance his penalty paid to Alliance bank. Here are the new home loan details:

• New loan amount = existing outstanding loan + penalty = RM160,498.80 + RM5721.33 = RM166,220.13
• New tenure: It is advisable to get the longest term possible because you will have low cash flow commitment but still have the flexibility to pay extra — in this case — 30 years

Comparison Methodology

In order to make a fair comparison, we will just look at the remaining outstanding loan after 4 years from now by paying the same installment of RM1243/month throughout the 48 monthly installment. For the loan package that provides the least outstanding principle loan result, it wins!

Without Refinancing

If Mr. Tan don’t refinance and stick with Alliance bank for another 4 years.

Image: Existing home loan details

Image: Existing loan repayment schedule

Note that the outstanding loan after 4 years is RM142,639.10 as highlighted.

With Refinancing

If Mr. Tan refinance his mortgage to OCBC bank by having to pay the penalty which is also financed in the new loan.

Image: New mortgage details

Image: New home loan repayment schedule

The outstanding loan after 4 years is RM138,919.89 as highlighted.

So the number actually tells the story: RM142,639.10 vs RM138,919.89.
If Mr. Tan refinance his home loan, he will be RM3719.21 richer after four years. Is it worth the hassle? Mr.Tan just need to meet me a few times to sign the offer letter. Everything is free! He doesn’t need to pay extra and the loan tenure is shorten to 17 years only! This is also the best time to refinance because if he decided to refinance a few years later within the lock-in period, the penalty is still the same because it is calculated from the original loan amount, not the outstanding loan.

Image: Penalty – worth to pay!

Conclusion: With proper analysis methodology and good advice from a financial consultant, you can save thousands ringgits to refinance your home loan even though you might need to pay penalty for early settlement.

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