Picking the best home loan package

Source : Business Times - 28 May 2008

Be aware of your financial needs and risk appetite while weighing home loan packages, writes HELEN NEO

WHILE owning a home is high on the must-have list for Singaporeans, the fact is buying a property usually means signing on for a mortgage. As banks compete for a larger share of the home loan market, borrowers are sometimes overwhelmed by the multitude of home loan packages, with differing features that cater to the different needs of homebuyers.

Not all homebuyers are savvy about all these features. Thus, it has become challenging for homebuyers to decide which loan best suits their needs. Here we show what is available in the market and discuss the advantages and disadvantages of each type of loan package.

Interbank-pegged vs home loan board rate (variable)

Features of interbank-pegged home loan

Pegged to Singapore Interbank Offered Rate (Sibor) or Swap Offered Rate (SOR) plus margin.

The Sibor or SOR can be easily obtained from the newspapers.

Sibor or SOR will be fixed for a period depending on interest period used and will change at rollover/maturity date.

Pros

Transparent: Your home loan interest rate moves in line with the market interest rate.

Cons

Volatile: Although interbank rates move daily, interest rates will only be repriced according to the interest period used, eg, for a three-month Sibor repricing is done once every quarter.

Pre-payment and redemption inflexibility: Prepayment or redemption for interbank-pegged packages are usually permitted only on rollover/maturity dates. Otherwise, a break fund cost may be imposed. This applies even if you had taken up a package with no lock-in period.

Administrative hassle: For those using the Central Provident Fund to service their monthly instalments, there are administrative issues to consider. As interbank rates are subject to frequent rate adjustments, this results in frequent changes to monthly instalments. For each change, customers would have to instruct the CPF Board to revise the monthly CPF amount released for servicing the loan. This results in inconvenience to customers, particularly if CPF funds are used in full for the payment of monthly instalments. Customers may need to update the board as often as once every three months.

Features of home loan board rate (variable)

Not pegged directly to any interbank rates.

Derived from overall bank funding costs (including business costs) from different sources. Maybank’s home loan board rate is benchmarked against interbank rates, market conditions, as well as business costs. This may differ for other banks. How often it is revised depends on each individual bank’s review of its portfolio against its benchmarked/reference market rates and business costs.

Pros

Not as volatile as interbank-pegged home loan packages.

Cons

Not as transparent as interbank-pegged rates. Each bank has its own way of computing its board rate(s).

Multiple board rates: Different board rates may be introduced at different times.

Home loan board rate (variable) vs fixed rates

Features of home loan board rate (variable)

With or without lock-in, there is a margin charged on top of the respective banks’ board rate.
Favoured by rate sensitive customers who also prefer more certainty in rates.

Favoured by investors mostly on no lock-in variable packages so that they can get out of the loan anytime without any penalty.

Features of fixed rates

Banks generally offer a choice of fixed rates for one to three years.

Interest rate certainty during the fixed period.

Favoured by risk-averse customers and those too busy to monitor their loan.

Not all customers will choose the lowest home loan interest rate package since much will depend on the needs and risk profile of the customers. For example, a young couple with no children and few financial commitments may consider taking on more risks compared to another with more financial commitments.

As for the choice between board rates and interbank pegged rates, this is very subjective. Some borrowers do not like the interbank pegged rates due to their volatility, but some like it because it is transparent.

Board rates usually lag behind in adjustment compared to interbank pegged rates because the bank will adjust them only after serious consideration of all factors (including interbank rate movements).

Looking at risk appetite, a person who cannot tolerate risk is likely to select a fixed rate package where they are able to determine with certainty the total monthly instalments they have to pay. Those likely to fall into this category are:

Young couples starting a family with a relatively high level of gearing to manage.
Older borrowers who do not like uncertainty in their financial commitments.

On the other hand, a person is likely to select an interbank-pegged interest rate if he has a higher risk appetite. The interbank rates are currently low and hence attractive; but it is also subject to market forces.

This uncertainty is translated to a different monthly instalment every few months. The effect is a fluctuating financial commitment during the loan tenure. Over time, the averaging effect may neutralise the low interest rates currently enjoyed.

The key is the option to exit the home loan when interest rates are on the uptrend. However, this option is not always available due to considerations such as a lock-in period, claw back period, income stability, and loan quantum.

Our take is that every loan package is designed to meet the needs of a particular customer segment. As a home loan buyer, you are making a decision for a long-term loan of say, 20 to 30 years. Be aware of your own financial needs before committing to a loan. Banks are generally more than willing to explain the differences between various loan packages and to analyse which is more suitable for your needs.

Helen Neo is head, consumer banking, Maybank Singapore.