Recently there has been much talk about the increasingly competitive home loan packages that are being offered. It seems like banks are trying to outdo each other in offering competitive rates on housing loans. There are so many packages when it comes to selecting a home loan. Some of these are fixed rates while most are floating rates pegged to certain parameters. It is understandable that home buyers or those that are looking to refinance do find it overwhelming when it comes to selecting the correct home loan for their property. This article is to deconstruct the various aspects of a home loan to enable you to better understand the mechanics and terms that are used in the various packages. We will then talk about the various things to look out for in your home loan contract with the bank.
So let us start breaking down the terms used in a home loan.
What is SIBOR?
SIBOR stands for Singapore Interbank Offer Rate. It is the interest rate at which banks lend unsecured funds to each other. Simply put, it is the interbank market rate. When someone deposits money in a bank, the bank will promise an interest to that person. The bank would not want to leave that deposit in its vault. It will want to lend money to other clients who need a loan or to other banks who may require extra funds. A bank has two aspects of a business. The first is to accept deposits from people who have excess money and the second is to lend money to people who require money. Certain banks may have more clients who require money than clients who have excess money and thus they may have a shortage of funds. The Monetary Authority of Singapore (MAS) also sets a reserve requirement for all banks. This is the amount of deposits that must be held in cash within the bank. At times the banks can have insufficient funds to fulfill these needs. This shortage can be made up by borrowing from another bank. The rate at which banks borrow from each other is called the Singapore Interbank Offer Rate or SIBOR for short.
What is SOR?
SOR stands for Singapore Swap Offer Rate. This rate is the expected forward exchange rate between the US dollar and the Singapore dollar. Simply put, the SOR projects what the interest rate would cost if the loan amount was borrowed in US dollars. Due to the fact that the SOR fluctuates along with foreign exchange markets, it is more volatile than SIBOR. In times when the US dollar is dropping in value against the Singapore dollar, the SOR may plummet greatly. However the converse may also happen and the SOR may spike when the US dollar is appreciating in value against the Singapore dollar.
What is FDR or FHR?
FDR or FHR stands for Fixed Deposit Home Rate. This is the Singapore fixed deposit rate of a particular bank. Banks have the liberty to offer fixed deposits to clients at their own rates. It would also be good to note that fixed deposit rates have a tenure attached to them. For example if you see FDR18 or FHR18, the 18 refers to the number of months. This means that the home loan is pegged to the 18 months Singapore Dollar Fixed Deposit Home Rate of that particular bank. As you can see, this rate is not entirely fixed as the bank can vary its fixed deposit rate. However it is still much less volatile than SIBOR and SOR. By raising the FDR or FHR, the bank must also pay more to clients who place monies into fixed deposits with them.
What is a spread?
The spread is the mark up that the bank places above the underlying perimeter. For example, the bank may charge a client a rate of SIBOR + 0.75%. The spread is therefore 0.75%. The spread is essentially the margin which the bank is making above the its cost of funds. SIBOR and SOR rates do not differ between banks but spreads vary from bank to bank.
As we can see, home loan interest rates have many varying factors to determine their rate. If you would like your home loan to have no fluctuations in interest rate, you should request for a fixed rate. A fixed rate ensures that your installment remains constant as the rate of interest does not change when SIBOR, SOR or FDR changes. However, because of this security, fixed rates are usually higher than SIBOR, SOR and FDR pegged rates at the point of inception. However there is still a chance that due to external forces, SIBOR, FDR and namely SOR rates may balloon and the home owner with a fixed rate may end up paying the least for his home loan.
What else do you need to consider?
Lock In Period
This is the amount of time that you need to stay with the home loan. Usually this lock in period varies from 1 to 3 years but we have seen home loan packages with tenures up to 5 years or more as well. There are also home loans with no lock in period. If you were to stop the home loan during the lock in period, this would most probably result in a penalty levied on the outstanding loan. Some reasons why someone may wish to stop a home loan might include the fact that the property is sold, the person is refinancing his home loan with another bank or the person would like to pay off the outstanding amount on the property (i.e. fully pay the property). This penalty is usually around 1.5% of the outstanding amount and can vary between banks and home loan contracts. This lock in period is very important when selecting a bank loan.
If you think that SIBOR rates will remain low for the next 1 to 2 years but may have a good chance of shooting up after the 2nd year, you may want to choose a lock in period of 2 years on your SIBOR pegged home loan. This way at the end of the 2nd year you have the option of refinancing to a fixed rate if the scenario does pan out the way you predicted. Also, you may want to sell the property which you just bought after 4 years to avoid paying any Sellers’ Stamp Duties (SSD). Thus you may take a home loan with 3 or 4 years lock in as the spreads may be lower. Usually the longer the lock in period, the lower the spreads. Conversely, if you would like to sell your property in the next year, you should take a home loan with little or no lock in period. In this case the spreads may be a little higher than one with a longer lock in period.
Partial Prepayment Penalty
This is the ability to pay off part of the loan. You may have a lump sum of cash or CPF monies coming in soon and would like to lower the outstanding loan on your housing loan to reduce the monthly installments. Most home loan packages do not allow for partial prepayment during the lock in period and may impose a partial prepayment penalty. In times when interest rates are low, you may chose to borrow a larger amount of money from the bank for your home loan purchase and leave your CPF monies to accumulate interest in your CPF account. This scenario holds true in today’s low interest environment. Home loan rates are going for 1.5% or less but CPF members are enjoying 2.5% interest on their deposits in their ordinary account. In fact the first $30,000 in the ordinary account received 3.5% interest. Thus you may decide to leave your excess monies in your CPF account and let it accrue interest at a higher rate than the interest you are paying on your home loan. Only when your home loan interest rate rises higher than the CPF ordinary account interest rate would you want to pay off part or whole of your housing loan with your excess CPF monies.
Early Redemption Penalty
This is the penalty which you will have to pay if you redeem or cancel the loan fully during the lock in period. This may happen for a variety of reasons but mainly happens when a property is sold during the loan lock in period. This amount is also in the region of 1.5% although it may vary across different banks. If you are thinking of selling your property in the near term, do take note of this term in your loan contract as you may have to pay a large sum of monies if the bank enforces this penalty.
Other Miscellaneous Cost
There are costs to refinancing a home loan. These costs include documentation fees and the cost of hiring a lawyer in the case of switching between banks. If you were to refinance within the same bank, there is usually a documentation fee which the banks charge and it can range in the range of $500 to $800. If you were to change banks, a lawyer would be required to disburse the new housing loan and this would cost about $2500. Fortunately banks usually subsidise part or whole of this legal cost to entice clients to make the switch. The subsidies and costs vary from bank to bank and it would be wise to compare between various banks to get the best deal. Also, if you decide to switch banks or if you are taking a new home loan then you will require a valuation report to be done on the property that is to be financed. This is required as the bank will base the loan amount as a percentage of that valuation. For example if the valuation of a certain property is $1 million and the purchase price is $1.2 million, the bank will only lend up to 80% of $1 million (If it is the client’s first housing loan and if his income and credit could support a loan of this amount). The cost of a valuation report is about $500 but this varies greatly as valuers are independent contractors. You just require the valuer to be under the bank’s accepted panel of valuers and the purpose of the valuation report should be to take a housing loan.
What are the documents needed?
The documents may vary from bank to bank but there are certain required documents which should be the same throughout.
- A copy of the applicant’s NRIC
- CPF contribution history for the last 12 months
- CPF property withdrawal details
- Income documents from the Inland Revenue Authority of Singapore (IRAS). Namely the Notice of Assesment
- Property portfolio (Can be retrieved through the IRAS portal)
- Last 3 months payslip
- All credit card, car loan, personal loan, study loan, renovation loan statements. (If any)
- Credit report (The bank may retrieve this on their own)
- A completed home loan application form from the bank which you are applying to
Essentially you may retrieve all these documents at the various government websites using your Singpass.
Finding the right home loan may be a little more complicated that you may think and this is the reason why many people end up selecting the wrong home loan packages and end up paying higher rates or penalties. All this can be avoided if you know what you should know when selecting a home loan. Alternatively, if you do not have time to go from bank to bank searching for the best home loan package, you may engage the services of a mortgage broker. Essentially taking a home loan from a mortgage broker will cost you nothing more than if you were to take it from a bank directly. However, a mortgage broker represents you the client as he is there to search for the best available package to suit your needs. Compare this to a banker who is tied to his principle. The banker draws a salary from his particular bank and has sales targets to hit. He only has his own banks packages to offer to you and thus your choice may not be the most informed if you only speak to one banker from one bank. For example, you may be refinancing your home loan and may want to do it with the current bank you are with. You have plans to sell your property in 2 years but the shortest lock in period for the home loan packages offered by that bank is 3 years. If you were to take up that package and do sell your property in 2 years you may have to pay an early redemption penalty. The alternative would be to seek advice from a mortgage broker. A mortgage broker is independent and works with all banks. He is given an introducer fee by the bank for every successful referral and this fee is generally the same throughout all banks. Thus his only incentive is to close deals and the only way to close a deal is to offer the best packages to the client. In the previous example, a mortgage broker would then recommend you a suitable package at a lock in period of 2 years to coincide with your plan to sell the property.
At More Assets Mortgage Advisory our mortgage advisors have years experience in the finance and financial planning industry. The goal has always been to look for the most suitable package to suit that particular client. Client risk profiling and needs analysis will be done free of charge to determine which particular home loan package is suitable for the client.
For more information, please visit: www.moreassets.sg/mortgage/
P.S. I hold the Chief Executive Officer position in More Assets Pte Ltd at the point when I wrote this article. This article was meant to be informative and hopefully would help home owners when they decide to take a home loan.