A legal clawback is a term contained in an agreement whereby one party has to pay back the legal fees in which the other party has paid or subsidised for the former.
While a clawback clause can be found in various types of contracts, one of the most common version of it in Singapore is the legal clawback found in the contracts of home loans between home buyers and banks.
This feature can play an important role in helping lenders retain customers as it indirectly puts up considerable switching costs that deter refinancing a mortgage with another banks.
Legal fees
Any type of secured loan will required borrowers to put up collateral in exchange for the credit facility.
A housing loan is essentially a loan against the property. And as such would place the house as the collateral that is secured for the loan.
This requires legal work which rack up expenses that the borrower would have to pay for closing.
To attract home buyer who are getting new loans and homeowners who are seeking refinancing, lenders can offer a legal subsidy that helps to fully cover the legal fees or substantially offset it.
The legal fees can run up to thousands of dollars depending on factors such as the type of house, size of house, and the value of the house.
Offering legal subsidies to pay for the necessary legal services can be immensely attractive to borrowers as they want to keep their closing costs as low as possible.
This legal subsidy can sometimes be disguised or be presented as a cash rebate, cash grant, or simply as a cash benefit.
And while this cash amount can seem like a drop in the ocean when compared to the considerable size of home loans, a few thousand dollars is not a negligible amount of money.
So much so that it can often be a swing factors that induces a borrower to choose the offering of a particular bank from another.
Legal clawback
As this cash investment has been made by the bank in order to secure a borrower, the bank would want to at least get that money back in the form of interest revenue that the borrower would pay towards the home loan for a few years.
This is why a legal clawback clause can be inserted into the loan contract that requires the borrower to repay the legal subsidy he or she had received under certain circumstances.
While there is no standard to how long clawback periods should last, it is usually set at 3 years from the commencement of the loan in practice.
And the condition that it might be triggered is usually a full repayment of the loan.
This means that if the borrower fully redeems the loan within 3 years for example, then he or she would have to pay back the full amount of the subsidy or cash rebate to the lender.
This can occur due to reasons such as:
- The property being sold
- The borrower refinances the mortgage with another lender
- The borrower receives a windfall and decides to settle the loan balance
- etc
This clawback is often reason enough for a borrower to delay any efforts to refinance the loan.
And during which, the lender would continue to collect scheduled monthly repayments on the home loan which is made up of a significant portion of interest revenue.
However, lenders who are eager to take over a loan from another bank might offer more cash rebates so that a borrower who is refinancing a mortgage to it can use the money to pay for the legal clawback.
Lock-in period
Something important to note is that the legal clawback period is not the same as a typical lock-in period of a housing loan.
A lock-in period on a mortgage basically imposes a penalty charge on the borrower should the loan be redeemed within a stipulated time period.
Some floating rate loans have no lock-in, while fixed rate loans typically have a lock-in period that runs parallel to the period of fixed rates.
While the mechanism of legal clawback and lock-in period is more or less the same, they are technically different.
If anything, the legal clawback is an indirect way of imposing a lock-in period to borrowers.
Even home loans with no lock-in periods can have legal clawback clauses.
This is so as to discourage borrowers from fully paying off a loan prematurely or face having to pay a financial penalty.
So do keep this clawback clause in mind when exploring refinancing or full redemption.
