99.co Picks, Finance

5 home loan terms and what they actually mean

May 11, 2016
Home loan terms, financial blackboard

Home loan terms require you to read between the lines

Everything except money is used to sell home loan packages. Smiling children, families on couches, happy pets…never before have 25 year prison terms (i.e. Mortgages) looked more reassuring. And the language just gets more confusing. Here’s how to decipher what those home loan terms in pamphlets really mean:

  1. Cheaper than HDB loan rates!

Really means……Just like every other bank loan!

Private bank rates have been lower than HDB loan rates since around 2008. So this is akin to advertising yourself on a job search by claiming you have not one, but two kidneys.

See, after the Global Financial Crisis, the American Federal Reserve lowered interest rates to stimulate their economy. This drove down the Singapore Interbank Offered Rate (SIBOR) and Swap Offer Rate (SOR), to which our property loans are pegged.

Now before the crisis, property loans had an interest rate of around 3.7 percent per annum. But in the aftermath of the crisis, typical rates were only around 1.7 percent (and are presently around 1.9 percent.)

So you see, before the crisis, HDB loan rates (around 2.6 percent) were cheaper than bank loans. It was a hiccough in the global economy that caused bank rates to become a lot cheaper than HDB rates. And this is the case in almost every bank you go to – just about everyone has a rate lower than HDB’s, and this has been the case for over seven years now.

  1. Protection from rising interest rates!

This often means you have (1) a longer interest rate period, or (2) fixed interest rates. And true enough, having a fixed rate means your interest won’t rise – at least for the given period (most fixed rate packages only last three to five years.)

But this comes with added protection: you’re also “protected” from finding a cheaper home loan rate.

Most fixed rate packages are more expensive than their floating rate counterparts – you’re paying for the additional stability. But they also come with lock-in clauses; typically, you will have to pay 1.5 percent of the undisbursed loan amount to refinance (switch to a cheaper package.)

So if you have a fixed loan with a two percent interest rate, and another comes along with a 1.82 percent interest rate, you’re stuck with the more expensive one. The penalties for breaking the lock-in will more than make-up for the amount you’d save on refinancing.

Think about that before you take a long, expensive fixed rate.

  1. Transparency!

Among all the home loan terms, I can’t believe this is even used as a selling point.

Are we to assume that, for other bank products, there isn’t transparency? This is like the banker telling you to trust him, because he’s never been to jail. It’s a basic requirement people, and that it’s used as a product feature is pretty shocking.

Anyway, the SIBOR rate is publicly available information, and has been forever. The transparency is no big deal. It’s just the average interest rate of 20 participating banks (the six “middle” range interest rates are averaged out to get the daily SIBOR rate.)

Back when we had Teletext, you could use it to look up SIBOR rates. Today you can just Google it (a number of sites will track it), or call your bank and ask.

  1. Low conveyancing fees!

It’s becoming rare for this one to appear, because most banks would rather you not pay attention to it at all. This refers to the $1,500 to $3,000 you pay to a law firm when you refinance, because filling in template documents is such hard work.

What you should know is that you can pick the law firm in question – the firm just has to be on the bank’s board. And you can save a fair bit by picking a lawyer who charges less (yes, they have different fees, for no fathomable reason.)

As an interesting aside, those of you taking HDB loans also pay conveyancing fees, and you can request to use a law firm of your choosing.

Again, it’s not so much a “feature” as a bank stating a thing you can do on your own. If you talk to a seasoned property investors, they can usually point you in the direction of a cheaper firm. Or try asking an independent mortgage broker.

  1. The rates are high on the fourth year, but you can refinance!

This one usually comes from the mouth of the mortgage banker, not the brochure. Most home loan rates spike on the fourth year, by a significant amount. Indeed, this is why property investors – who don’t want interest rates to eat into their resale profits – often refinance before it happens.

When you see the “fourth year and thereafter” rate is high, the mortgage banker will hand wave it as an irrelevant detail. Repayments will go up by almost $400 a month? Pshaw, who cares, just refinance when it happens.

Thing is, no one knows what the situation will be four years from now. There may not be a cheaper package to refinance into. Also, you have to remember that refinancing means applying for a loan all over again. Because you’re older, and your income could drop, there’s no guarantee that you will qualify for a new, cheaper package when the time comes.

As an example, consider some borrowers who took loans before the Total Debt Servicing Ratio (TDSR) rules came into place. They settled for the lowest rate for the first three years, and didn’t care about the fourth before they assumed they could refinance.

Then the TDSR was announced, which places tighter restrictions on how loans are disbursed. Now some of those borrowers find they won’t qualify for cheaper loans, and are stuck with their existing packages.

In short, don’t fall for the “it’s easy to refinance” speech. Pay attention to the final interest rate after the “teaser” years, and make sure your cashflow won’t choke and die if you’re stuck with them.

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