Tuesday, 27 March 2012

Home loans: Weigh your options

Fixed or floating rate? Locked in for how long? Better to think long-term
By Magdalen Ng, The Sunday Times, 25 Mar 2012

Property is never far from the minds of Singaporeans. And why not? We all want four walls to call our own. But bricks and mortar can be a minefield - especially when it comes to loans.

A mortgage is a huge commitment, it goes without saying, and the temptation with interest rates so low is to borrow big and go for a posher home. What could go wrong?

Well, the obvious hitch is that rates, which are at rock-bottom levels, can and must go up. That means an affordable mortgage could fast become a millstone around your neck.

Says DBS Bank's head of deposits and secured lending, Ms Lui Su Kian: 'Home owners should understand how rising interest rates will impact their repayments.'

That means a borrower needs a stable income, and knows down to the last cent what his or her monthly cashflow and other outstanding liabilities are.

Ms Chia Siew Cheng, United Overseas Bank's (UOB) head of loans division, notes: 'One important factor that home buyers should consider when purchasing a home is their ability to repay the loan over the long term.'

Banks play their part by reining in the over-enthusiastic and trying to restrict loans to viable levels. Yet, there is still a myriad of offers out there for borrowers to consider.

With so much choice, making that crucial decision can be difficult. The Sunday Times examines some of the options.

1 Fixed or floating: which is better?

A fixed rate package means the interest rate is set for a period of one to three years usually. The actual rate varies across lenders.

Typically, rates for fixed packages are higher than those for floating ones, as you pay a premium for having certainty about your payments, which are fixed even if interest rates rise.

A survey of six banks shows that fixed rates range from 1.18 per cent to 1.38 per cent in the first year for a two-year lock-in period.

Floating mortgages have the interest rate pegged to an index, which may fluctuate from time to time, causing your repayments to rise or fall in tandem.

Floating mortgages are usually pegged to the Singapore Interbank Offer Rate (Sibor), the Swap Offer Rate (SOR) or the CPF Ordinary Account interest rate, and the board rates of each bank.

Sibor is the rate at which financial institutions lend unsecured funds to each other, while the SOR is based on a formula that takes into account the current and expected exchange rates of the US dollar against the Singdollar and the local interbank lending rates for the greenback.

Both of these rates are published daily in The Business Times.

Sibor and SOR have been hovering at near-historical lows over the past six months, making floating rate packages extremely attractive.

Banks tack a bit on to whatever benchmark they use. It is called the spread and represents their slice of the deal.

The average spread being offered for a three-month Sibor-pegged loan ranges from 0.75 per cent to 0.9 per cent.

Based on Friday's three-month Sibor of 0.4 per cent, the interest rate would be 1.15 to 1.3 per cent, lower than fixed rates.

The downside to floating rate packages is that those benchmarks can rise. Sibor hit 2.23 per cent in September 2008, its highest level in three years. That would have put mortgage rates at more than 3 per cent.

There is no cap to how high Sibor can go, but economists seem agreed that it will stay low for the next two years.

Banks are also at liberty to vary the spread.

OCBC economist Selena Ling says short-term Singdollar interest rates 'look fairly well anchored, especially since the US Federal Reserve has committed to keeping exceptionally low interest rates till late 2014'.

Ms Ling expects the three-month Sibor at the end of the year to be 0.45 per cent, a slight uptick from the current levels of close to 0.4 per cent.

On the other hand, HSBC Global Research forecasts that the three-month Sibor will stay at 0.4 per cent until the last quarter of next year.

Mr Alvin Liew, senior economist at UOB, believes the United States Federal Reserve may be forced to increase interest rates in the third quarter of 2014, given the possibility that inflation expectations will rise significantly that year.

'If US rates start to climb, Singapore interest rates will also start to move higher,' he said.

The CPF Ordinary Account interest rate is derived from the rates of the local banks and is reviewed every three months. From November to January, the rate was 0.16 per cent. However, as legislated by the CPF Act, the minimum interest rate is 2.5 per cent.

Board rates differ across the banks. It is unclear how these rates are derived and they are not easily available.

This may mean a great deal of uncertainty as to how your monthly repayments will change. Since 2006, there has been a push for greater certainty, and banks are offering fewer of these packages linked to board rates.

One-month, three-month, or 12-month Sibor?

The Sibor is the rate at which banks lend to each other, so the one-month Sibor is the interest rate for borrowing money for a month.

Correspondingly, the three- month and 12-month Sibor are the interest rates for loans for three months and a year respectively.

Given that lending money for longer periods of time entails slightly more risk than a shorter-term loan, the one-month Sibor is generally lower than the three-month Sibor, which is in turn lower than the 12-month Sibor.

The 12-month Sibor is equivalent to a one-year fixed rate, and should be considered if you expect Sibor to take a sharp upswing in the second half of the year.

However, if you expect interest rates to remain fairly level and do not mind having minor adjustments to your monthly repayments, the one-month Sibor may be suitable to your needs.

Some banks do offer packages where you are allowed to switch between the three rates.

Financial advisers say that in the current economic situation, most of their clients are fearful of interest rates going up.

However, Mr Derrick Ang, director of mortgage sales at consultancy portal SingaporeHousing Loan.sg, says: 'With the fact that interest rates are at their lowest, the only way to go is up.'

He added that which package clients eventually choose depends on what the customer thinks of the current low interest rate trends.

If they think interest rates will continue to stay low, it may be better to go for a floating package.

2 Lock-in periods

The lock-in period refers to a pre-determined number of years during which the borrower has to pay a penalty if he changes the terms of the contract, either by cancellation, prepayment or conversion.

Most fixed-rate packages come with a lock-in period, but floating rate packages can give the option of having no lock-in.

A lock-in period can last for as long as two years, so ask your bank if such a package has a better interest rate than one with no lock-in.

If you are buying a property for investment and may sell the property within a short time period, it may be better to take the package without a lock-in period, since you will not incur any penalties. Those penalties range from 0.75 to 1.5 per cent of the loan.

3 Freebies that banks offer with their loan packages

The standard offering across banks would be:

1. Legal fee subsidy, of up to $2,500 at some banks.

Others absorb the legal fees completely, but only if you go to certain law firms.

2. Fire insurance for the first year at private homes and HDB developments.

3. Valuation subsidies should also be part of the deal.

Even if your package does not come with a lock-in period, there is an average claw-back period of three years for these freebies, which means the bank will make you pay them back.

Banks occasionally do throw in other perks, such as furniture or shopping vouchers, to sweeten the deal. If your banker is not offering you anything, it does not hurt to ask.

4 Loans for HDB flats

When you buy a Housing Board flat, you can borrow from the HDB or a bank.

When Sibor and SOR were at highs of more than 2 per cent in 2008, the HDB, which pegs its loans to the CPF Ordinary Account interest rate set at a minimum of 2.5 per cent, was considered more attractive.

The interest rate for an HDB mortgage now is 2.5 per cent plus 0.1 per cent, so it is 2.6 per cent.

In these days of a low interest rate environment, it may be better to go with a bank loan.

However, the loan quantum for a bank loan on HDB developments is capped at 80 per cent of the property price, but an HDB loan can go to 90 per cent.

You will also need to cough up more cash upfront if you take a bank loan instead of an HDB one.

HDB loan quantums are about $250,000, which is significantly less than those of private properties, so the interest rate differential may be less significant.

5 Developer tie-ups a win-win?

In the past, banks could offer interest rate absorption until the project was completed, which certainly sweetened the deal, but this is no longer allowed by the Monetary Authority of Singapore.

There are now few exclusive tie-ups between banks and developers, and at showflats, there will usually be more than one bank.

The rates offered by the banks present will certainly be competitive, but shop around in case something better is available.

6 Relationship with bank may get you a better deal

Most banks do reward customer loyalty and take your relationship with them into account when making a mortgage offer.

For example, customers who have substantial assets under management by a bank, and perhaps a business relationship as well, may be offered a customised package with lower interest rates than those publicised.

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