If your home loan is up for refinancing, you must be thinking whether to go for a fixed- or floating-rate loan right now, seeing that rates are on the rise.
While it may be painful to lock in a rate that is above 3% for the next 2 or 3 years, it is equally heartbreaking if you go for a floating rate now and face a 5% (or more) interest rate somewhere down the line.
The era of low interest rates is unlikely to return anytime soon, and there is no ceiling on interest rates for floating rate packages. In other words, the sky could very well be the limit. But of course, the government will possibly step in with measures to cool the market should rates shoot through the roof.
In a 30 June 2022 report, CNA warns homeowners to brace themselves for a “big interest rate shock”.
The US Federal Reserve
Currently, the US is facing unruly domestic inflation. To tame this, its central bank – the US Federal Reserve – has, up to June this year, revised its interest rates upwards three times. The bad news is, there are more hikes to come.
Besides inflation, the Fed is also upping its interest rate due to post-pandemic supply chain disruptions, the Russia-Ukraine war, and oil and gas price increases.
Being a small and open economy, any movements in the world’s biggest economy will have an impact on Singapore. Which is why, many Singapore homeowners are now playing it safe to either go for a fixed-rate loan or a hybrid.
Sorry, what’s a hybrid?
Those of you who are just entering the world of homeownership may be finding such jargon along with terms like SIBOR, SOR, SORA and bank spread a steep learning curve. Let us now give you a crash course on Singapore’s home loan lingo.
First, the terminologies
SIBOR stands for the Singapore Interbank Offer Rate. Set by a panel of some 20 banks (minimum 12) under the Association of Banks in Singapore (ABS), SIBOR is the interest rate at which banks borrow from one another. Changes are highly transparent, and it is closely tied to fluctuations in the US Federal Reserve.
SOR is the acronym for Swop Offer Rate. SOR relies on the USD LIBOR, which have been discontinued.
SORA, which is short for the Singapore Overnight Rate Average, are backward-looking overnight rates. Banks in Singapore started offering SORA-pegged home loans in 2020. Compared to both SIBOR and SOR, which are forward-looking rates, SORA is considered more stable.
Banks stopped issuing new SIBOR- and SOR-pegged loans in 2021, and SOR and SIBOR will be discontinued in 2023 and 2024 respectively.
FDR, which is the fixed deposit home rate, is a board rate pegged to the bank’s own deposit rate. The Monetary Authority of Singapore (MAS) monitors FDR hence changes are somewhat transparent.
Bank spread is the additional percentage that the bank earns from the borrower on top of the cost of lending the principal.
Fixed-rate home loans
In a fixed-rate home loan, the interest rate remains the same throughout your loan tenure. This is called the lock-in period, and it is typically 2 or 3 years, but could be anything between 1 and 5 years.
Once the lock-in period lapses, your loan switches to a floating rate, which can be pegged to SORA, FDR or the bank’s board rate, depending on the home loan package that you signed up for.
During this lock-in period, you are advised not to opt out or refinance (i.e. switch to another bank) unless you do not mind paying hefty partial/full prepayment penalties of between 0.75% and 1.5%. This is one of the drawbacks of a fixed-rate loan.
There are two other disadvantages. Firstly, fixed rates are usually higher than floating rates. Secondly, when the loan tenure is about due, you have to start looking for a new loan package. Besides the hassle of hunting for a new loan package, you have to spend about $3,000 in legal fees.
With these disadvantages, then why do people still go for fixed-rate loans? And why do we say that now’s the time to go for one?
Fixed-rate loans are a good choice in a scenario where interest rates are expected to rise further (i.e. now). Though the current rates may not be all that attractive, it is still better than when it goes up even further.
Fixed-rate loans give you peace of mind, and a sense of constancy and certainty amid all the volatility. If you’re currently having a low-risk appetite or on a tight budget and cannot stomach too much fluctuations, then go for that fixed-rate loan.
Interest rates were low during the Covid-19 pandemic
Floating-rate home loans
For floating-rate home loans, the interest rate varies according to changes in the lender’s benchmark rate. Previously, when loans were pegged to SIBOR, this interest rate could change every month or every three months.
As market forces govern the floating-rate loan, the amount you pay in monthly instalments will change according to the changes in interest rate. This means that you will rejoice when the rates plummet, but start getting agitated when it spikes.
Can you stomach the seesaw movements of a floating rate loan?
Floating-rate loans may come with or without a lock-in period. If it does, you are well advised not to refinance during the lock-in period to avoid paying penalties for the outstanding loan amount. However, unlike fixed-rate loans, there could be some leniency for floating-rate loans in terms of partial repayment.
Floating-rate loans are ideal when interest rates are set to fall, or when you anticipate getting a small windfall in the near term (e.g. a bonus) to pay towards the loan.
Hybrid-rate loans, as you may have guessed, is a combination of fixed- and floating-rate loans. Borrowers can structure up to half of their loan amount in fixed rates and the remainder as a floating rate. Compared to a fixed-rate loan, hybrids are typically lower and helps borrowers to better manage their interest expenses amid a volatile interest rate environment.
HDB concessionary rate
Fixed-, floating- and hybrid-rate home loans are offered by banks to private homeowners such as condo buyers. If, however, your property were an HDB flat, you would be well advised to stick to the HDB concessionary loan.
Pegged at 0.1% above the prevailing CPF Ordinary Account rate (currently 2.5%), the HDB concessionary loan rate has remained at 2.6% for the past 20 years. This is far more attractive that the 3.08% rate announced by UOB in late June.
However, many homebuyers chose to switch from their HDB concessionary loan to a bank loan in the past couple of years because of the latter’s attractive rates. Now these homebuyers cannot switch back to the HDB concessionary loan. Let this be a lesson to those who are still on their HDB concessionary loan to ponder carefully before making that switch.
In this article, we’ve outlined for you what fixed- and floating-rate home loans are and why you should go for the former in today’s context. 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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