Compared to the HDB home loan which is straightforward and easy to understand, banks’ mortgages are usually more complicated. So uncover how they work, and how each type differ from the other.
Breaking it down
A HDB home loan offers predictable repayment instalments as its interest rate remains relatively fixed throughout the entire loan tenure, pegged at 0.1% above the prevailing CPF-OA interest rate, which has remained unchanged at 2.5% since July 1999. In contrast, bank mortgages are notorious for their ever-changing repayment instalments. So, are bank home loans always bad? It depends. Let’s first take a closer look at the 2 most common bank home loans below.
Chart 1: Types of home loans offered by banks
The interest rate of fixed rate loans is ‘locked’ (aka doesn’t change) for the first few years while that of floating rate loans usually keep changing as they are pegged to moving benchmarks (e.g. SIBOR, fixed deposit rates etc.). Hence, in return for its predictability, fixed interest rate loans are generally more expensive than floating rate loans.
Table 1: Types of home loans offered by banks
Floating interest rate home loans
Floating interest rate home loans usually come bundled with a bank spread (aka a premium that the bank charges you) and the benchmark that the interest rate is pegged to (see Table 2). So, a floating loan package usually looks like this:
Table 2: The 2 parts of floating rate home loan
Pros and Cons
Depending on the prevailing market outlook and how much volatility you can handle, you might start with one type of mortgage and switch to another midway through your loan tenure (see Table 3).
Table 3: Pros and cons of each type of home loans
Impact of interest rate on your monthly repayment instalment
Granted that we want the lowest possible interest rates, but the crucial part of taking up a loan is to predict your affordability, especially if the interest rate is floating. By calculating how much your monthly repayment instalment will increase in the event of an increase in interest rate, especially when the SIBOR have been moving in an upward trend in the last 5 years (see chart 2). So, if you have gotten a SIBOR-pegged floating rate loan in 2015, your interest rate would have increased by more than 1%!
Chart 2: 5-year Median 3M SIBOR rates from January 2015 to May 2019
For better understanding of the effect of an increase in interest rate, we compare the difference in monthly repayment amount for a $400,000 loan with a 25-year tenure.
HDB loan where interest rate remains at 2.6% for the entire tenure; and
Bank loan pegged to 3M SIBOR where interest rate continuously increases over 5 years#.
#Out of the 4 major banks in Singapore, DBS, POSB and UOB has no SIBOR pegged loans hence, we are only using OCBC’s rate is 3M SIBOR floating rate package.
Table 4: Average bank rate for home loans that are pegged to 3M SIBOR
Table 5: Difference in interest rate, monthly repayment amount and total interest paid for both loans
*Interest paid for both loans for periods 2015-2019 calculated using CPF’s Total Interest Calculator
Although a 0.5% difference in interest rate has only a $100 impact on your monthly repayment, this difference will add up in the long run due to the amortization nature of home loans (where a bigger portion of your monthly repayment is used to pay off interest first). However, before you denounce HDB loans as “bad” purely due to its higher interest rate as compared to 3M SIBOR floating rate, we need to remember that the SIBOR pegged loans will lose its shine if SIBOR continues to move in an upwards trend because the interest rate may rise well above 4% after adding in the bank’s spread!
If you’re thinking of taking a bank loan to finance your property, it is very important that you are savvy about what you’re getting into and also knowing when and how to refinance. If you want to find out more, Chloe and her team is more than happy to be of service!
Comments