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Tuesday, 30 January 2018

A quick guide to home loan

ummul azkee

A quick guide to home loan

So you are ready to buy your first home for yourself. You did your research and finally decided to
purchase a unit of HDB in Tampines, for example. What is the first thing you should do? Hunt for
the best housing loan packages, of course. The guide below would serve as a guidance for potential
home buyers for their HDB when they are shopping for their housing loans to finance their HDB

For starters, one of the most challenging tasks when shopping for a home loan is to choose between
a fixed rate loan or a floating rate loan. Is fixed rate always better than floating rate, or vice versa?
To answer this question, you have to form your opinion about how rates will behave in the next 2
to 3 years while your loan is locked up, and how that impacts your overall cost. Below, we discuss
a few possible scenarios that you should consider and how to take advantage of each type of loans
in these situations. But before that, most potential HDB owners would be wondering, what are fixed
and floating rate loan? A fixed interest rate loan is a loan where the interest rate doesn't fluctuate
during the fixed rate period of the loan. This allows the borrower to accurately predict their future
payments. Variable rate loans, by contrast, are anchored to the prevailing discount rate. As for
floating rate loan, a floating interest rate, also known as a variable or adjustable rate, refers to any
type of debt instrument, such as a loan, bond, mortgage, or credit, that does not have a fixed rate of
interest over the life of the instrument. Both of the loans are means to a purpose, for potential buyers
to finance their HDB purchases but they work differently in some ways.

Fixed Rate Is Better in a Rising Interest Rate Environment
When the interest rate is rising, fixed-rate loans can give you up to 10% of cost savings by locking in
the current (low) interest rate. According to our analysis of 2000-2017 historical interest rates, you
could save as much as S$16,641 by choosing fixed rate if you took out a loan of S$400,000 in 2005,
when the market rates began to rise steeply. These estimates are based on interest rate of 0.50% plus
the benchmark 6-month SOR, a 3-year fixed-rate period. We also assumed that the rate continues
to rise to 5.00% until 2022, after which the rate stays constant. The result consistently held true for all
three time periods, as long as they represented a rising interest rate environment. For instance, you
would've save about S$10,169 in interest cost compared to floating rate if you took a fixed-rate
mortgage starting 2014, because interest rates have been steadily rising during 2014-2017.

Basically, fixed rate loans to fund your HDB purchase would only be beneficial during bad economic
outlook where the banks offering the loans are offering loans with higher and higher interest. Because
the interest rates are fixed, you won’t be affected by any future increase of the loan rates. However,
the downside of this would be that after a while, the economy would stabilize and interest rates start
to drop to lure more potential borrowers. Some might argue economic appreciation of the HDB in
Tampines, for example would be worth the extra paid for the interest.

Floating Rate is Better in a Flat-to-Declining Interest Rate Environment
In a flat-to-declining interest rate environment, you can save up to 8% of interest cost by choosing a
floating interest rate, according to the same analysis as above. We can find a prominent example in
year 2007, when the 6-month SOR peaked out at 3.52%. As the interest rate kept declining, the floating
rate adjusted each year to the lower market rate, but fixed-rate loans were locked in at these sky-high
rates. As a result, you could've saved about S$12,675 or 6% of total interest cost if you took out a floating
rate loan of S$400,000 in 2007, compared to its fixed-rate counterpart. It is also generally more advisable
to get a floating rate loan in a flat interest rate environment. This is because banks typically charge you
higher interest on fixed-rate loans in order to reflect the premium you are getting from knowing exactly
how much to pay each month.

Because the fixed-rate period typically lasts for 3 years, almost all of your interest cost savings happen
during that time. This means that if you took out a fixed-rate loan of S$400,000 in 2005, over 86%
(S$14,382 out of S$16,641) of the savings would come in during the first three years, while the remaining
14% happens over the remaining 27 years. This also represents about 38% of interest cost reduction
in the first three years. The ratios stay relatively constant regardless of which year the mortgage starts,
meaning that the majority of your net position is determined in the first three years, unless you choose
to refinance  your mortgage.

This essentially means that the bulk of your cost savings would be at the initial stages of the loan
financing the purchase of the HDB, providing there are no revisions to the loan interest rates during
the years. If the rates are revised due to economic reasons, it would be wise to look to refinance the
loan in order to prevent paying for a higher interest.

Low Interest Rate Also Helps You Pay Down More Debt 
Not only does low interest rate reduce your cost in the first three years. In fact, it can also help you
pay down relatively more principal each month, which in turn helps you pay less interest down the
road.Let's take a look at an example of how this would have worked in your favour in 2005, when the
interest rate was rising. If you took out a S$400,000 mortgage loan with fixed rate, over 50% of your
payment in the first 3 years would've been "principal repayment." This is beneficial for you because
principal repayment decreases your outstanding debt balance, which ultimately results in less interest
costs. However, if you took the same loan with floating rate, only about 30% of your payment in the
second and third years (2006 and 2007, respectively) would go to pay down your debt.

In the end, the choice is up to each individual buyer to decide which package that suits them most
when it comes to financing their HDB purchase. For those who are afraid of rising interests for the
housing loans, they should opt for the fixed rate packages offered by financial institution. And for
those buyers who are more willing to wet their feet in the market and take some risk, a floating rate
loan might suit their risk appetite. There’s no right or wrong in this matter, mainly the preferences of
each individual.

ummul azkee / Author & Editor

"A self motivated women with hundreds of challenge. Its all about how to get strength to face the challenge of life and to make dream come true. Arts is the way I motivate myself to be a strong women, remind me to stay positive in all challenge that will come in my life.Learning about realities of life that might comes and never give up."


  1. Info yang bagus untuk yg plan nak beli rumah.. Thanks UA..

  2. terus teringat kat loan rumah yang bakal start bulan ni... huwaaaaaa.. 30 tahun lagi baru abis hutang rumah.. huhuhuhu.. :p


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