Today, we are going to discuss a few of the types of interest rate packages that you need to look out for when you are getting a mortgage loan letter of offer whether its a fixed rate package or a floating rate package. We will share with you what are some of the differences between these two packages, as well as some advantages and disadvantages that you need to look out for and of course, what kind of packages are usually suitable for what kind of investors.
The Loan Quantum (Amount)
The other thing that you need to look out for in a mortgage loan letter offer itself is the loan amount. The Loan amount specifies the amount that will be the eventual amount that the bank intends to lend to you in your property purchase.
Loan Tenure Period
Next, the tenure of the loan, which is how long the loan itself can stretch for and whether there is any lock-in period and the last thing will be the maturity date whereby the outstanding loan, the interest, any fees, will all be payable by this stipulated dateline.
Fixed Interest Rates
For fixed-rate, by the definition of it, it means that the interest rate is fixed for the duration of the loan or for a certain period of the loan – commonly a 2 or 3 year fixed period at this point of writing.
Some of the more applicable uses of fixed interest rates are for personal loans, car loans where there is a specific interest rate that doesn’t change for the entire duration of the loan. For fixed interest rates for the Mortgage Loan, banks usually offer a loan package where for the first two years or three years, you are paying a definite interest rate for your monthly mortgage instalment.
Advantages of Fixed Interest Rates
What are some advantages to choosing a fixed interest rate? Firstly, the elimination of uncertainty. This means that no matter how the interest rate environment changes, during the fixed interest rate period of the loan.
What we have seen is that when there is a lot of uncertainty in the market environment, some of the banks do offer a longer period of up to 5 years fixed interest rate where this might be an opportunity for you to capitalise on in a rising interest rate environment.
What it means today is, if you were to sign a mortgage loan fixed package with the bank, let’s say, assuming 2.5% for the next two years. Even if market interest rates were to move much higher, say 2.8% or 3%, you will be safeguarded against this increase and continue paying the fixed 2.5% for the full-year period that you have agreed with the bank.
There is a lot more certainty in your mortgage interest rate in terms of your monthly instalment. This would make it more suited for those with a fixed flow of monthly income. There is no uncertainty to manage your monthly mortgage instalment and great for those that prefer looking for stability whereby you do not experience any fluctuation within this fixed period where the loan interest rate has been confirmed.
Disadvantages Of A Fixed Interest Rate
On the flip side, in exchange for a more stable fixed interest rate, the interest rate would usually be higher at the point of signing up for the loan packages vis-a-vis a floating rate package. You are not able to do any partial or full principal repayment during the lock-in period.
Why is there a lock-in period when you choose a fixed interest rate? It’s because, for this interest rate to be fixed for one or two years, banks will usually put in a clause where for usually the same period, you are not able to reduce any of your capital repayment. It’s just like a mobile phone contract where you are being bound by the two years’ contract and any other termination will result in a breach of a contract. But in recent times, banks have actually offered this flexibility whereby you can actually make a partial capital repayment during the lock-in period, which some banks are actually offering right now.
Assuming we are in a falling interest environment. If you have taken up a mortgage bank offer with a fixed interest rate for the next two years at 2.5%, you will be locked-in for the next 2 years. During this period, if the market interest rate environment were to fall, say to 2% or 1.5%, you will not be able to capitalise because you have been bound by this agreement whereby you need to pay this 2.5% for the next 2 years.
Floating Interest Rate
Moving on to the next floating interest bank rate. How it works is usually, there will be an underlying index which the interest rate will be pegged to. In most recent times, banks have been using your 3-months SIBOR or 1-month SIBOR. SIBOR is the abbreviation of the “Singapore Interbank Offered Rate”. In layman terms, that is the rate that banks lend money to one another – a spread that the bank is taking.
How this ties into the floating interest rate package is that there will be an interest rate that the bank will offer for 3-months SIBOR plus 0.3%. That will make up the interest rate that you are paying for that year for your mortgage loan.
Advantages Of Floating Interest Rates
One of the advantages of taking on a floating interest bank rate is, it is more transparent. You are able to source the information online. It could be 3-month SIBOR via the association Bank of Singapore website or even when they are pegged to a fixed deposit rate that is able to be found easily within the bank’s website, and of course, the other advantage would be the opportunity to capitalize in a falling interest rate environment. Of course, when you have a floating interest bank rate, the rate will fluctuate according to the market environment. Just to give you an example, if this interest rate were to continue to fall, for example, the 3-month SIBOR, you will be able to capitalize on this opportunity and pay less interest for your mortgage instalment over that period of time.
Who will be suitable for this kind of floating bank interest rates? One group that we can think of would be for people who are property investors where they will want to keep their amount of interest that they are paying to the bank as low as possible and having it pegged to the market conditions.
Disadvantages of Floating Interest Rates
Some of the common disadvantages in the floating bank interest rate i
s fluctuation in your monthly loan instalment. Just to cite an example, if your loan were to be pegged to a 3-month SIBOR, it will mean that every 3-months, the SIBOR rates will be reviewed and at that point in time, how much interest rate you are paying will be determined. If that happens, your monthly mortgage instalment will actually increase higher. But of course, it might go the other way and you will actually benefit from it and for the banks itself, they usually will take on a higher spread, typically after two to three years.
For example, today if you were to be pegged to a 3-month SIBOR, this will increase the spread that the bank is taking. Maybe it could be 0.3% for the first year and subsequently, after the second year, it becomes 0.4% and thereafter, it might become 0.5%. Effectively, the bank itself is charging a higher spread as the number of years goes by for your mortgage loan.
Lastly, you will actually be losing out in the rising interest rate environment which is what we are experiencing right now in recent times where SIBOR has actually gone up almost from the time of Lehman Brothers crash and during the 2008 financial crisis.
So that sums up the differences between a Fixed and Floating Interest Rate Mortgage Loan Package.
Hope this was useful for you.
See you soon.
