Unless you have enough cash on hand to pay off the entire price tag of your brand new home, most first-time home buyers rely on home loans of some kind, be it from their preferred bank or the Housing Development Board (HDB) itself. However, loans have to be returned eventually — with interest — and many homeowners spend years, even decades, paying the home loan off. How does the repayment work, and what does ‘amortisation’ mean?
This article will cover…
- What is loan amortisation?
- How does it apply to home loans in Singapore?
- How do you calculate loan amortisation?
- What are interest-only loans?
What Is Loan Amortisation?
‘Loan amortisation’ might sound complicated at first, but the concept is really quite similar to how loans and monthly repayments work. Essentially, loan amortisation breaks down one’s loan repayments into small, consistent chunks, and you get to repay both your principal and interest at the same time. This repayment method allows borrowers — in this case, homeowners — to clearly and easily manage their loans over time, because they pay the exact same amount each month.
How Does Amortisation Apply to Home Loans?
As mentioned above, loan amortisation makes it easier for homeowners to manage their loans on a month-by-month basis, since both the principal and interest are repaid in equal-sized chunks. Other factors (such as a partial repayment, a progressive disbursement, or a change in interest rate) could impact the process, but this is generally how it applies to home loans for most homeowners.
Another point to note is that while there are other ways to repay home loans in other countries, loan amortisation is the only mode of repayment in Singapore — that is, since interest-only loans were banned in 2009, but more on that later.
How to Calculate Loan Amortisation
One easy way to think about amortised loans is that it is basically your monthly mortgage instalment. With that in mind, let’s make a few assumptions: You and your partner are purchasing a condominium for $1 million, 70% of which (or $700,000) will be covered by a bank loan with an annual interest rate of 2.6%. Let’s also assume that the loan amortisation will take place over the course of 20 years. In which case, your monthly repayment schedule will look something like this:
Month 1
2.6%
$697.773
$3,743.52
$1,517
$2,227
Month 2
2.6%
$695,541
$3,743.52
$1,512
$2,232
Month 3
2.6%
$693,305
$3,743.52
$1,507
$2,237
–
–
–
–
–
–
Month 240 (20 years)
2.6%
$0
$3,743.52
$8
$3,735
If you choose to make prepayments on your home loan, keep in mind that it will mean that you pay down the overall principal of the loan faster. For example, if you pay $100,000 one month in the above scenario, then the total amount of principal owed will be less than what it would have been if you stuck to paying $3,743.52 that month. This will also reduce the total interest you’ll owe over the duration of the loan, so do adjust accordingly.
Check out the complex formula yourself, or speak to a Home Finance Advisor for help calculating your monthly repayments.
Just FYI: What Are Interest-Only Home Loans?
In the course of your research, you might come across something called ‘interest-only mortgage’ or ‘interest-only loans’. Put simply, an interest-only loan is a type of loan in which the borrower is required to pay only the interest on the loan for a certain period of time. The principal, on the other hand, is repaid either as a lump sum on a later date or in subsequent payments. And because you are paying for just the interest at first, the repayment amount is usually much lower than amortised loans when the repayment first begins.
This is part of the reason why interest-only loans were incredibly popular in Singapore — that is, until they were disallowed in September 2009.
There are two main reasons why interest-only loans no longer apply in Singapore. First, it encouraged property speculations. In the past, some buyers would purchase a private property in Singapore while it was still under construction and opt for an interest-only loan. However, right before the construction was completed and the principal repayments kicked in, these buyers would sell the property as quickly as possible to earn a significant profit. The decision to disallow interest-only loans, then, was to clamp down on such practices.
The second reason was to discourage overexposure. One of the downsides of interest-only loans is that, once the principal repayment kicks in, the amount is usually significantly higher than when it was just the interest repayment.
While this might not be a problem under normal circumstances, the sudden increase in financial burden could become a major challenge especially if it coincides with a downturn in one’s financial situation. For example, if the homeowner loses their job or experiences a medical emergency, there’s a very real possibility of not being able to repay the loan. Of course, such risks also apply to other home loan options, but the jump for interest-only loans is significantly greater, thus creating a potentially bigger burden for financially uncertain homeowners.
Seeing all the repayments you have to make across the entire loan tenure might seem overwhelming at first, but trust us when we say that loan amortisation makes the entire process much more manageable.
We hope this article helped you understand the concept of home loan amortisation better. For more home financing resources, read our Guides or have a chat with one of our Home Finance Advisors (it’s free!).
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