As the saying goes: What goes up must come down, and the reverse is true as well. So be prepared—mentally and financially—for a day where interest rates will climb once again. Will you be able to manage the mortgage then?

To help home owners and investors with the decision-making process, we map out the types of housing loan packages available in Singapore today. We also look at historical data to help you analyze your options at this juncture.


Fixed Rates and Variable Rates
Housing loan packages in Singapore can be broadly defined into two categories: fixed rates and variable rates.

1. Fixed Rates: A fixed-rate loan locks the interest rate for the first few years. Subsequently, the interest rates will be variable and typically benchmarked against a reference rate (often referred to as floating rates). In Singapore, the lock-in period is usually three years, and sometimes, five years.

There are three drawbacks, however, of this option:

• This is often the most expensive option, as it offers security and a peace of mind that you will be protected against potential interest rate hikes.
   
• Be aware of the early repayment charge or redemption penalty. By guaranteeing a fixed interest rate, financial institutions (FIs) actually bear more risks for the volatility and uncertainty of the market interest rate. To compensate, they would typically charge borrowers more money if they repay the loan before the end of the fixed rate period, these periods are also known as loyalty periods. Sometimes, these charges can carry on for a time (called extended tie-ins) even after the fixed rate period ends. An example of a common loyalty period is 1 year and breaching the agreed period incurs a penalty of typically 1-1.5% of the outstanding loan.

• Take note of the claw-back period. FIs sometimes offer discounts, subsidies, and other perks to entice borrowers. The downside is that during this period, you cannot fully repay the loan without paying back for these ‘goodies’.

As a result, this loan package is most suitable for those who want certainty over their cash flow and are unlikely to sell their property within the next three to five years.

2. Variable rates: There are two things to note:

There are two types of variable rates—board rates and published rates.

Board Rates

These rates will change during the loan tenure. There is a premium that will be added on top of the variable rate. This is usually fixed and is set by the individual FI

The FIs set the board rate, and they often do not reveal how they arrive at the figure. This rate may not fall in tandem with the Singapore Interbank Offered Rate (SIBOR), which is the lending cost between local banks.

Published Rates
 
To counter this lack of transparency, FIs introduced packages that are pegged to published rates, which include:

• SIBOR, which moves in tandem with market conditions thereby providing a certain level of transparency to the consumers who can look at market trends to confirm the rates they are paying are genuinely tied to the economy.
   
• Singapore Swap Offer Rate (SOR) represents the average cost of funds used by banks in Singapore for commercial lending, or the cost of borrowing SGD by borrowing USD for the same tenor and swapping the USD in return for the SGD.
   
• CPF Rate

The upside is that regardless of whether the rate moves up or down, borrowers can be sure that they are paying based on transparent market rates.

Variable vs Fixed Interest Rates
Real estate investors who need financing to purchase property will inevitably be faced with the choice of variable or fixed interest rates. However, the volatility of interest rates does not allow anyone to predict future trends. The best way to make your decision would be to keep abreast of the latest economic happenings and political situations by reading the newspaper, business magazines and market reports in order to develop a better understanding of the market.

Analyzing Published Rates

1. CPF rate: It is the deposit rate that one will receive for his/her funds inside the CPF Ordinary Account. As stipulated by the CPF Act, the minimum CPF interest rate is 2.50% p.a. This means your home loan interest rate will not drop below 2.50% p.a. Thanks to the government, however, this is also the most stable rate and has been at 2.50%p.a. since July 1999.

This option is most suitable for the risk-adverse, who wants to know how much they are paying.

2. SIBOR and SOR: They are more volatile (see Chart 1) as they reflect the state of the economy (i.e. rates will be higher during the boom and lower during the recession). The borrower will decide how frequently they want to revise their interest rate. A 12-month Sibor will be higher than a three-month Sibor as the interest will be locked for one year before it is revised again. It is the same for SOR as well.

Pegged To Economic Performance

Chart 1

We observed from Chart 1 that both rates peaked during September to October when the financial crisis became prominently visible with the collapse of major investment banks like Lehman Brothers. During this period, there was a severe shortage of cash and banks were skeptical about lending. This prompted a sharp spike in interest rates.

But the situation changed when central banks worldwide started slashing interest rates in their bid to ease the tightening market and improve liquidity. Some banks, including the Bank of England and the European Central Bank have now raised rates in accordance with the recovering economy but interest rates still remain at very low figures.

In Singapore, since Jan 2009, the 3-month Sibor has stayed at a low rate of 0.69%.

Is The Time Right?

For home owners and investors who wish to refinance their loan, do assess the situation and seek advice if in doubt. There could be a penalty that might cost them more than the savings they conserve from the low interest rate.

Chart 2

1997 Property Boom: During the 1997 Property Boom, investors and home buyers alike flocked to purchase real estate. The Property Market being a sentiment driven industry further increased in activity with the advent of such buying and as a result, 1997 saw the largest spike in Sibor rates in the illustrated 16-year period as the government increased interest rates in an attempt to cool the rapidly overheating market which drove Sibor rates up as a a consequence.

Asian Financial Crisis: The Asian Financial Crisis in 1998 caused interest rates to plummet from record highs to new lows as the government struggled to inject liquidity into the markets in order to boost consumer spending and stimulate the economy. This drop was reflected in the Sibor rates which were lowered drastically to encourage home buying and investing.

Dot.com Bubble Burst: The Dot.com Bubble finally burst after approximately 3 years of rapid expansion which led to many “paper millionaires” or investors who were overnight millionaires when their dotcom companies who often paid them in preferred shares went public. The speculative bubble finally burst and even though an estimated $5 trillion was lost during the fiasco, the effect was not really felt in Asia though the impacts on a rocked US economy was reflected in a small but distinct enough drop in Sibor rates as the shockwaves rippled worldwide.

2007 Property Boom: In the 2007 Property Boom, a similar scenario to the 1997 Boom occurred but on a smaller scale as consumers and investors were more cautious in a post-9/11 era. Nevertheless, speculative investors and home buyers took advantage of the low Sibor rates in 2004 to start buying property, once again driving up interest and Sibor rates as the government tried to curb a property bubble from forming.

US Subprime Crisis: The US Subprime Crisis, unlike the Dotcom Bubble, has had a major impact globally as nations around the world struggle to cope with the impact of the world superpower’s ailing financial system which has collapsed under its own weight and resulted in lower than ever consumer confidence and spending. Governments around the world are slashing interest rates to near 0% in a desperate attempt to inject liquidity and get cash flow moving again in order to revive their stagnant and dying economies. As of January 2009, the steady Sibor rate of 0.69% has reflected the global outlook of bleak economic movement and sentiment.

Ultimately, we advise borrowers to be prudent, and not to be too focused on the short-term gains. With reference to Chart 2, interest rates may be at a level that is advantageous to you now, but it may not last for long. You must be absolutely sure that you will still be able to manage the mortgage even if the interest increases by 1-1.5%.

As investment guru Warren Buffet once said, “Our favorite holding period is forever.” The strategy for the current market climate would be to use ‘cheap money’ to buy an undervalued property, rent it out, and wait for the value to appreciate when the market recovers.

Remember, as long as your rental covers all your expenses (e.g. mortgage cost, maintenance fee), it is an asset that you should keep for the long haul.

Mortgage Loans: Bank’s Lesson From Clayton Homes

Berkshire Hathaway, Warren Buffett's investment company, owns Clayton Homes, which is the largest maker and financier of pre-fabricated and mobile homes in the US. These homes are the most popular with buyers who have credit problems and who are prime candidates for subprime mortgages. Yet Clayton Homes managed to sidestep the severe subprime mortgage losses that plagued its counterparts in the housing and loan industry.

This goes back to Buffet’s investment fundamental saying, which is: “When we (Clayton Homes) make a mistake in making or buying a loan, it costs us money, not some buyer thousands of miles away." On the same note, do not be too happy too early with the current housing loan situation. Here’s why:

• The availability of low interest rates is not equivalent to the approval of the loan.
   
• Banks are still dishing out home loans, but they are also more selective these days.

• The rule is that banks can grant up to 90% of the purchase price or valuation, whichever is lower. If the sale price of a property exceeds the valuation (an amount that is determined by an independent professional), the buyer will have to make up the shortfall.
   
• With the current economic situation, however, banks have a more stringent credit approval process. After all, mortgage default is one of the main causes of today’s crisis.

• Most banks now prefer to offer up to only 80% financing and some loans are only applicable to completed properties for fear that developers may go into bankruptcy in today’s market environment.

• Banks now exercise more discretion during the screening process especially if the property is the buyers first or second. Creditability and credit history may be scrutinized more seriously now.
   

Here is an overview of some of the pegged-rate loan packages offered by some of the local and overseas banks (as of Jul 09):

With record sales of 2,767 units in the private housing sector for the month of July alone, the total sales figure looks set to break 2007 property boom heights of 14,811 with over 10,000 units already sold up till August. This has resulted in even smaller banks like the State Bank of India (SBI) looking to grab a slice of the lucrative home loan pie with interest rates going as low as Sibor plus 0.6% for the first year as reported in The Straits Times on the 19th of August. While the general consensus being banks will continue to maintain tight lending rules in the aftermath of the subprime crisis, they will be looking to entice new buyers with attractive interest rates and packages in their attempt to recoup the losses suffered last year during the crisis. This may lead to the beginning of a “Mortgage War” where multiple banks compete to dominate the market.

*Pls click here for Tip: Purchase/Market Price vs. Bank Valuation