There is great debate amongst home owners about the best type of interest rate to save money. It is not as simple as choosing the lowest interest rate number. The two main types of interest rates are fixed or floating. Each type has its advantages and disadvantages, depending on the type of borrower you are.
What is a fixed rate package?
Fixed rate packages are home loans that maintain the same interest rate over a period of time, usually between one to five years. Once the lock-in period is over, the fixed rate becomes a floating rate.
During the period of the fixed rate, the bank is essentially taking on the risk of the interest rate fluctuating. As a result, they charge a premium by setting fixed rates higher than floating rates.
This type of rate package is ideal for borrowers who value stability and want to budget precisely for their mortgage payment. You would choose this option if you anticipate interest rates to go up.
What is a floating rate package?
Floating rate packages are a bit more complicated because they are calculated and vary as the market rises and falls. Floating rates are interest rates that fluctuate according to SIBOR (Singapore Interbank Offered Rate) and SOR (Swap Offer Rate) rates. There are 2 main types of floating rate packages: a SIBOR-pegged home loan and a SOR-pegged home loan.
A SIBOR-pegged home loan is based on the SIBOR, which is the interest rate that banks in Singapore charge to each other. The SIBOR is more steady than the SOR. Therefore, SIBOR-pegged home loans are ideal for borrowers who prefer a more consistent repayment schedule and anticipate the interest rates to stay low.
A SOR-pegged home loan is based on the SOR, which is very similar to the SIBOR, except that it reflects the exchange rate between SGD and USD. This is important because Singapore is part of the international market and work with other international banks. As a result, SOR is more volatile than the SIBOR. However, both rates move in tandem. Therefore, when SIBOR is up, SOR is up as well. SOR-pegged home loans are ideal for borrowers who want to take more risks and hope that when interest rates fall, SOR will fall more than SIBOR.
It is worth noting that before 2007, most home loans in Singapore had a floating board rate. This means that the interest rate is essentially tied to the bank. It is calculated based on the benchmark interest rate plus a “spread,” which is the bank’s profit. As a result, your monthly payment would vary, as the interest rates vary.
However, in recent years, SIBOR or SOR loans are becoming more and more common because the way they are calculated seem more transparent. Furthermore, these rates are available to the public, published by the Association of Banks in Singapore.
Overall, floating rate packages tend to charge lower interest rates at the outset. The SIBOR and SOR will determine how high or low the rate will be in the future. Floating rate packages can come with lock-in periods.
However, it is usually not advisable to simply refinance with a cheaper loan package every time interest rates rise. Refinancing comes with fees and if interest rates start to go up, all bank interest rate packages will also eventually go up. A borrower must have a good understanding of the home loan market, calculate whether the savings from the lower interest rate will be more than the penalties and fees incurred, and act quickly in order to derive significant savings using this method.
Let’s Talk Numbers
In our hypothetical scenario, you are a Singapore citizen looking to purchase a S$300,000 property with a 20% cash downpayment. Your loan amount is S$240,000 over the course of 25 years.
With a 2 year fixed package, your interest rate is 2.48%. You pay S$1,074 monthly for the 1st and 2nd year. Thereafter, your rate is floating and stays at 2.66% for the rest of your mortgage. Your total repayment is S$328,143.
With a SIBOR-pegged home loan, your first 3 years has an interest rate of 2.11% with a monthly payment of S$1,031. The 4th year and thereafter, your interest rate stays at 2.51% with a monthly payment of S$1,078. Your total repayment is S$321,817.
With a floating board rate, your interest rate is 2.08% for 2 years with a monthly payment of S$1,027. In year 3, your interest rate rises to 2.60% with a monthly payment of S$1,089. Finally, in year 4 and thereafter, your interest rate increases and stays at 2.88% with a monthly payment of S$1,123. Your total repayment is S$334,225.
In this real home loan comparison, the best choice is a floating SIBOR home package. The SIBOR-pegged home loan yields a cheaper total repayment than the fixed package. On the other hand, the floating board rate yields a more expensive total repayment than the fixed package. However, remember, your rate is variable and dependent on the market. It is difficult to predict how the rates will be years from now.
Fixed rates are for borrowers who prefer financial certainty. For example, a borrower with medical issues may choose a fixed rate in order to budget for other expenses.
On the other hand, floating rates are ideal for borrowers who are financially secure and have a greater risk tolerance who can withstand the market surges. This type of borrower should venture to understand the home loans market and can closely track rises and falls. The best interest rate depends on how much risk you want to take, as well as, your financial security.
With all the options available, there is a perfect home loan package for you.