If you’re taking out a home loan, chances are you’ll come across the term “lock-in period”. Though it may sound off-putting, what really does it mean and is it really disadvantageous to the homebuyer?
What’s a lock-in period?
Lock-in period explained
The lock-in period simply means that, if the borrower wants to enjoy the special promotional rate offered by the bank, he/she cannot switch to another bank during the lock-in period. If he decides to refinance or redeem his loan before the lock-in period is up, the borrower will have to pay a penalty, which is usually 1.5% of the undisbursed loan amount. Refinancing occurs when you switch to another bank while redemption happens when you’ve decided to sell off the property.
For example, if you take a $1 million loan and have paid $200,000, this means you still have $800,000 in undisbursed loan. If you decide to refinance during the lock-in period, you have to pay $800,000 x 1.5%, which is $12,000 in penalty. This could possibly negate the savings that you enjoyed from the promotion in the first place.
Take note too that some banks may impose additional fees on top of this penalty.
Depending whether you chose a fixed- or floating-rate loan, the lock-in period can be anything between 1 and 5 years. In the case of a fixed-rate loan, the lock-in period is the same as the loan period because the loan duration is by default the lock-in period for fixed-rate loans. Hence, if you took a 5-year fixed-rate loan, then the lock-in period is 5 years.
Will the savings from refinancing offset the penalty?
The short answer is “no”.
Just say you signed up for a loan package with bank X this year. It’s a 5-year fixed-rate loan. As explained above, the lock-in period is 5 years since this is a fixed-rate loan.
Two years down the road, you come across a much better deal, and you’re itching to refinance. Don’t. Chances are you’ll lose more than you gain.
Stuck with one but interested in another?
What happens if you’re in urgent need of funds and have to sell off your house within the lock-in period? You’ll still have to pay the penalty unless there was a clause stating that you could get a waiver for such circumstances. In other words, read your contract carefully before signing on the dotted line if you feel that your situation may change in the near future.
If there’s a penalty, why do people still sign up for loans with lock-in periods?
Simple. They want to enjoy the promotional rate, which is usually 0.3% lower than those without lock-in periods.
Supposing you’re buying a house for your own-stay and you know that this is for the long haul. You come across an attractive 5-year fixed-rate loan package with a 3-year lock-in period. Would you go for it? Why not?
As far as you’re concerned, you’re satisfied with the rates for the first 3 years. You know that rates only shoot up from the fourth year onwards, but by then, your lock-in period is over and you’re free to shop around for a better deal.
For a snapshot of how rates change over the years, check out our article on bank loans for buildings under construction here.
Are there exceptions to the rule?
- Removal of prepayment penalties
- Waiver on lock-in penalty for re-pricing
How nice it is to be able to bypass the rules
Removal of prepayment penalties
First of all, let’s explain what a prepayment penalty is.
Let’s say one year into taking out a 5-year loan, you get a windfall. With the extra cash in hand, your line of thoughts start to go along this path: “Why should I continue to take this loan and pay so much extra in interest? I’m still within my lock-in period, so if I refinance, there will be a penalty. But what if I tell my bank I want to pay more “down payment” now? That will lessen my loan and my interest payments. But will they accept this?”
If you get a windfall during your lock-in period, you may consider topping up the payment towards your property
If you had signed up for a loan with a “removal of prepayment penalty during lock-in period” clause, you could very well have your wish granted. This means you wouldn’t need to pay the penalty of 1.5% (usually) on the loan amount redeemed. This is as though you’ve refinanced to a cheaper loan package.
The caveat is: usually there’s a ceiling to how much loan amount you can redeem before the penalty kicks in. Well, something is better than nothing, right?
But, if you are lucky enough to come across a loan package with a “full waiver of prepayment penalty during lock-in period” clause, grab it with both hands, especially if you have intention to sell your property within the loan period.
In this case, you can redeem the loan in full (via sale of the said property) and not incur a single cent in prepayment penalty.
Waiver on lock-in penalty for re-pricing
Earlier, we mentioned that there would be a penalty when you refinance your loan during the lock-in period. Refinancing here means switching to another loan package from another bank.
However, if you switch to another (cheaper) loan package from the same bank, this is not considered as refinancing. In this case, some banks may offer a waiver on lock-in penalty for re-pricing. If your bank happens to allow this, you’re in luck should there be a better package in the future.
To lock in or not to lock in
Don’t look at lock-in periods as a major deliberation factor, so much so that it impedes you from achieving what you want. There’s a good chance that the lock-in period will not affect you at all.
Don’t be paralysed by the choice you have to make
Refinancing isn’t exactly the most enjoyable activity, so most people just stick with their loans until the lock-in period is over. If in the meanwhile, loan rates go up, then rejoice that you’ve made a good choice. If it goes down, then that’s just too bad. You win some; you lose some. That’s life.
In this article, we’ve explained what the lock-in period in housing loans mean. If you want to know more, schedule a visit with us or book a free consultation with our trusted and renowned representatives.
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