This article provides some pointers when choosing a home loan during a low interest rate climate, particularly in Singapore.
Prevailing Interest Rate Environment
Be aware of the prevailing interest rate situation. During a low interest rate environment, a bank loan will usually offer lower interest compared to the HDB concessionary loan.
For example, last year when interest rate in Singapore fell to an all-time low, some borrowers of banks home loans enjoyed rates of less than 1% per annum (p.a.). In contrast, the rate on the HDB loan remained at 2.6% p.a..
However, for a bank loan, there are various types. The most common being the fixed- and variable-rate loan. So which should you select?
A fixed-rate bank loan in Singapore has its interest rate remaining unchanged for the first 3 to 5 years; after which the rate will be pegged at a discount below the financing institution's board rate or floating rate.
Whereas for a variable-rate loan (aka floating-rate loan), its interest rate fluctuates for the entire loan duration. Typically the rates are pegged at a margin (termed spread) above the SIBOR (Singapore Interbank Offered Rate) or SOR (Singapore Swap Offer Rate).
During a low-interest rate environment, a variable-rate loan typically has lower interest rates relative to a fixed-rate loan. This is because SIBOR or SOR is depressed.
Thus, as a rule of thumb, opt for a variable-rate loan during a low-interest rate climate if you are looking for interest-saving. Nevertheless, there maybe other considerations in deciding on a home loan.
A variable-rate loan comes with more uncertainty in the monthly repayment amount. This may not be ideal for people who want stability in their monthly financial outlays. In such cases, a fixed-rate loan or a HDB loan maybe more suitable; as the former provides the same rate during the fixed period. For the latter rates have remained constant for over 10 years.
However, uncertainty in monthly repayment amount for HDB loans is still possible. For example, in the 1990s its rates demonstrated more volatility (Source: CPF, “Historical HDB Concessionary Interest Rate”).
Apart from monthly repayment instability, another drawback of a variable-rate loan is the possibility of an interest rate spike when interest rates start to swing upwards. When this happens, the rates on a variable-rate loan can exceed a fixed-rate loan.
Conversely, you can select a variable loan with an interest rate cap, but there is a catch. The spread on these loans are higher than for normal variable-rate loans. For instance, the latest interest-rate cap loan to be offered is the POSB HDB Loan, but it has a spread of 1.38% p.a.
The other interest-rate cap loan on the market is the DBS Mortgage Rate Protector, which spread stands at 1.15% or 1.25% with a DBS Mortgage Insurance. Both are SIBOR-pegged loans. Currently, many SIBOR-pegged loan has a spread of less than 1%.
Ultimately, whether a variable rate loan is for you will depend on how savvy a borrower you are (for instance you can time the variable-rate loan such that your are out of the lock-in period when rates climb, so you can refinance to a cheaper loan), your risk profile, and whether the benefit of interest-savings outweigh the instability in monthly installment.
The guidelines provided in this article should not be substituted for professional advice. Do speak to a professional mortgage consultant if you are planning to take a new loan or refinance. Singapore's mortgage consultancy usually does not charge for home loan advice.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Singapore Business Review. The author was not remunerated for this article.
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Susan Teo is a writer for research-focused Singapore mortgage consultancy firms: Property Buyer, iCompareLoan and Singapore Home Loan, which offer free professional advice and use reports from Singapore's best loan analysis system (exclusive to them) to help borrowers select the best property loan.