Understanding Mortgages: When is the Lowest Interest Rate Not Necessarily the Best Interest Rate?
If you’re a young married couple looking to purchase your first home in Singapore and want to find the most suitable home loan for your needs, low interest rates can be enticing. However, the cheapest mortgage may not always mean the best outcome for you in the long run.
With the recent COVID-19 crisis that has resulted in American Federal Reserve rate cuts, the SIBOR (Singapore interbank offered rate) has dipped significantly, allowing banks to offer much more attractive home loan packages. The 3-month SIBOR in Feb 2021 currently stands at 0.403%, which is very low when compared to recent years’ trends. As such, now seems an opportune time to refinance your mortgage to a cheaper package.
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While it is true that like many homeowners, you can potentially enjoy significant savings by refinancing to a cheaper package during this period, there are situations when these low rates are not necessarily the best or most suitable for you.
Understanding SIBOR Rates
First, let’s understand what SIBOR is.
SIBOR is the rate banks borrow from one another and is tied to various global factors. The recent COVID-19 pandemic has proved favourable for the SIBOR, keeping it at a record low. The 3-month rate has fallen 1.5% from May 2019 and has stayed below 0.41% since September 2020. This is correlated with the US Federal Reserve Rates which were slash to near zero earlier in March 2020 to alleviate the economic impact caused by the pandemic.
However, what goes up must come down. Most analysts predict that the SIBOR will remain relatively low until 2023, after which it will increase again. That said, these are only predictions made based on the current situation and assuming nothing significant changes. One thing that’s important to remember is that the SIBOR is forward-looking and moves according to market sentiment, and hence any significant developments that cause market confidence to recover. The recent COVID-19 vaccine announcement, for example, could very well cause rates to rise again and send all predictions out the window. That said, SIBOR is planned to be phased out by 2024.
Generally, SIBOR has the following qualities:
- SIBOR fluctuates based on market conditions
- SIBOR is volatile, with rates changing drastically (positively correlated with the U.S Federal Reserve rates)
- There is no concrete way to say what the SIBOR will look like in future, though market trends are a good indicator
- As a published rate, SIBOR is relatively transparent and can be monitored
With the SIBOR so low, most mortgages are going to be able to offer lower rates as well. When should you not jump at the bait?
Scenario 1. You Are Switching Because of Financial Distress
Suppose you and your significant other are stuck in a HDB loan and are looking to get out of the higher interest rate package by opting for a bank loan instead. Due to the low interest rate environment now, finding one that is lower than the HDB rate of 2.6% per annum is going to be easy. It might seem like a no-brainer: HDB does not have any penalties to switching to a bank loan, refinancing the loan would enable the couple to save more money for family planning, and the lower monthly repayment can be an ideal situation.
However, you may want to think twice if you’re thinking of making the switch due to severe financial distress. Switching from an HDB loan to a bank loan is irreversible (i.e. you cannot go back to HDB after). Plus, banks are generally known to be stricter about repayment than HDB. If you are refinancing to reduce the struggle of paying for your mortgage, opting for a low rate may still lead to struggles anyway when property and global markets bounce back.
Do note that there may be an impact of this financial distress on your credit rating. That, in turn, could also affect your ability to refinance to a cheaper mortgage.
Scenario 2. The Fine Print for The Lowest-Interest Loan Package Makes it Less Attractive
Your mortgage isn’t just about an interest rate number. Every loan package comes with additional parameters (what many consider to be the "fine print") that should also be taken into account as they affect the overall attractiveness of the package. In the case of what appears to be the "cheapest" package, these may well affect how "cheap" it actually is for you, not just in money, but in time. You will need to consider all these additional factors when refinancing, not just fixating on the interest rate as your main criterion.
To give an example, one factor you need to take into account is the lock-in period. Most refinancing loans have a lock-in period of about two years, with a partial or full penalty for paying off your loan early. This is highly likely if you have chosen a low and fixed interest rate.
There are also many packages with low “teaser” rates in the first few years, followed by high interest rates thereafter. These may seem the cheapest option at first glance, but if you work out the sums, the long-term costs can add up and negate the short-term savings.
Do your research thoroughly and make sure that every portion of the contract is understood before you enter a situation you might not be able to get out of without incurring large financial penalties. If you are unsure or bewildered by the small print, our PropertyGuru Finance Home Finance Advisors can help you interpret them and give you a more holistic big picture of how ideal a low-interest-rate loan package really is. In addition, they can also help you find a loan package from among all the major banks in Singapore that is more suitable to your needs.
Low Rates Can Lead to Significant Savings, But Not Always
When considering what loan to take based on their rates, always bear in mind the element of time–an interest rate is not only a number, but also a trend, and always subject to change.
Brush up your knowledge of finance and the economy to understand how rates may change based on events in the world, so you can take a long-term view to assess what really is a good interest rate. Also, make sure you assess the rate against your own situation and means because every loan situation is always subjective.
If you haven’t the luxury of time for this, then be sure to seek advice from those who know, so that you won’t find yourself falling into an unpleasant situation later on from the pursuit of a short-term gain.
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