Dubai: With over 10 interest rate hikes recorded in most economies since 2022, homeowners worldwide have felt the effect, particularly those making monthly payments on their home loans at variable interest rates.
As opposed to fixed interest rates, which stay unchanged for the term of the loan, rate hikes prove costly for loans with interest rates that fluctuate over time. But can you improve your loan terms after they have already been agreed to and you are at least a year into making your payments?
“It makes sense to contact your mortgage lender at least once a year to ask about lowering your interest rate, adjusting the term of your loan, or maybe even refinancing it into a different type of loan,” explained Jose Paul, an Abu Dhabi banker with over two decades experience in the field.
“Doing so could save you a significant amount of money each year because the rate you have with your mortgage loan now isn’t necessarily as low as it can ever be. Although rates are rising now, that wouldn’t be the scenario in a year’s time. So it helps to periodically check in with your loan issuer.”
Step #1: Examine if your monthly home loan interest, term can be lowered
While the most common way to lower your mortgage payment is to make a bigger down payment when buying a home, even during the middle of the loan term you can refinance it, which is replacing your current home loan with another loan under a different term and interest rate.
“When refinancing your home loan, you need to first consider whether the monthly savings is enough to make a positive change in your life, or whether the overall savings over the life of the loan will benefit you substantially,” explained Anil Pillai, a Dubai-based banking industry analyst.
“The rule of thumb is that you'll benefit from refinancing if the new rate is at least 1 per cent lower than the rate you have. If your financial situation has improved since you first took the loan, you can qualify for a lower interest rate, which will save you money on your monthly payments.”
Again, it's worth a call to your lender to determine how much you could save in interest by refinancing to a shorter term loan. If your budget can handle the higher monthly payment, this move can save you plenty of money in the long run.
Also, when paying off a Dh200,000 mortgage with a fixed interest rate of 4.25 per cent, you'll pay more than Dh154,000 in interest if you take the full three decades to pay off that loan. But if you refinance to a shorter-term loan, you can reduce the interest you pay over the life of your loan.
If you owe Dh185,000 on that same loan, and refinance it to a 15-year, fixed-rate loan with an interest rate of 3.8 per cent, you'll now pay just more than Dh57,000 if you take the full 15 years to pay off the loan. But as your loan term is shorter, keep in mind monthly payments will be higher.
Step #2: Calculate how much refinancing costs can eat into your loan savings
Although to get to the above savings you will have to refinance and replace your existing loan with a new one with a lower interest rate, it will cost you some money upfront — often as much as Dh3,000 or more.
“Refinances aren't free. It is estimated that a refinance can cost 2 per cent to 6 per cent of your loan's outstanding balance in closing costs. If your rate doesn't drop by enough, you might not save enough money each month to recover these closing costs for four years or more,” added Paul.
Let’s go back to the previous example and say you decided to refinance when you have a remaining balance on your loan of Dh180,000. You qualify for an interest rate of 4.25 per cent for your new 30-year, fixed-rate mortgage.
At that rate, your monthly payment will fall to about Dh885. You'll be saving about Dh215 a month, or about Dh2,580 per year. If your refinance costs 3 per cent of your outstanding loan balance of Dh180,000. That comes out to Dh5,400 in closing costs, which will take you years to pay back.
Step #3: Budget an extra amount to pay more towards the borrowed amount
So in other words, while refinancing often comes with financial rewards, it's also costly and time-consuming. “If you can't drop your interest rate by enough, you won't reap enough monthly savings anyway,” said Pillai.
“But there is a way to reduce the amount of interest you'll pay over the life of your loan and shorten the number of years it will take you to pay it off: You can pay a bit extra with each mortgage payment.”
Let’s say you have 25 years remaining on a 30-year, fixed-rate mortgage loan of Dh200,000 with an interest rate of 4.5 per cent. If you pay an extra Dh100 toward your loan's main balance each month, you can reduce the time it takes you to pay off that loan by three years and nine months.
You can also save nearly Dh21,000 in interest payments over the life of the mortgage. “If you can handle the small extra payment, this could be a smart move. So ask your lender how paying extra can shorten the term of your loan and lower the amount of interest you pay,” said Paul.
If you’ve been struggling to make your monthly mortgage payments on time, or if you are worried that you won't be able to make your payment next month, you can approach your lender to lower your payments even after the loan agreement has been signed.
“Your lender might be willing to reduce your interest rate temporarily or lengthen the term of your loan so that your monthly payment is lower. And if you are able to make small extra payments each month, it will validate your case before a lender even further,” Paul added.
“An alternative is to refinance to a mortgage with a rate that stays in place throughout the life of your new loan. You might qualify for a refinance that comes with a rate that while higher than your current rate, will be lower than the new rate as rates continue to rise in the months ahead.”
While the first step is to ask the lender if you might now qualify for a lower interest rate, it’s key to find out if the monthly savings from the new rate will be high enough to justify the cost of paying for a refinance.
Because keep in mind that homeowners pay different refinancing costs in different countries. So you might pay more to close your refinance, which would mean an even longer payback time, reiterated Pillai.