Property loans you didn’t know existed

Someday, banks will decide to describe their property loans in a language that human beings use. Until then, you’ll have to do your best to work out what they’re saying. Demand numbers, ask experts, tell the mortgage banker to act it out in a game of charades – whatever it takes to not end up washing your clothes in a canal. On the upside, we can have a greater understanding of the more unusual options:

1. Internal Board Rate (IBR)

Most commercial property loans have an interest rate pegged to the Swap Offer Rate (SOR). Most residential property loans have an interest rate pegged to the Singapore Interbank Offered Rate (SIBOR). So what the heck is IBR?

To put it in a simplified way, think of it as striking a private arrangement with the bank. Your interest rate is still variable; but rather than following SIBOR or SOR, the rate is based on whatever the bank decides. Most of the the time, the bank will promise a better rate than what is available on the market. They may also point out that their rate has been fixed for a long time, even if it is technically a floating rate.

Is this a good idea? It depends on how much you trust your bank. Some people will believe IBR exists to cater to a specific demographic, called “people with no common sense”. Others believe we should be open-minded, and that IBRs can offer a better rate.

In general, when taking an IBR it’s best to check what you can get out of it. Should your bank decide to spike the rate, you don’t want to realise you’ve signed a lock-in clause and can’t refinance. Think carefully before deciding to entrust such a large loan to the whims of your bank.

2. Combination Loans

These packages “split” a single home loan into two or three different parts, each part following a different set of rules.

For example, say you take out a loan for S$800,000. A combi-loan might break that loan into two separate parts of S$300,000, and S$500,000. The portion that is S$300,000 may have a fixed interest rate of 1.8 percent per annum, whereas the portion that is S$500,000 may have a floating rate pegged to SIBOR.

Another possible example is that the first S$300,000 is pegged to SIBOR rates, while the remaining S$500,000 is pegged to SOR rates. Banks can get quite innovative in how they combine these “Frankenstein loans”.

Combi-loans are inadvisable for the regular homeowner, and are rarely offered to them anyway. Most of the time, these are created for commercial property investors, who have certain cash flow needs.

In the rare cases they are offered to you as a home buyer, you are better off getting an independent mortgage broker to work out whether it’s worth it. Numbers-wise, this is the kind of thing that makes rocket scientists frown and reach for calculators.

We’re not saying it’s bad though – in some cases, it might save you quite a lot of money, and make monthly repayments more tolerable.

3. Interest Offset Loan

These loans are for people who also want to open a deposit with the bank. The interest rate on that deposit is used to pay the interest rate on the property loan.

For example, say you deposit a sum of money (the bank will tell you how much is needed), and you get an interest rate of 0.8 percent per annum. Instead of paying you this interest, the bank instead deducts from the property loan that you take. So if your property loan would be 1.8 percent, the interest would be reduced to one percent.

Interest offset loans tend to work best if you are very rich, and the bank offers you an unusually high interest rate (which may happen if you are depositing $5 million or something). However, it is also used by people who don’t intend to invest the money they deposit.

While we are not an investment site, we feel obliged to point out that the average insurance policy earns returns of five percent per annum. There are probably better things you can do with the money than use it to lower your home loan interest, is our point.

4. Hybrid Loan

Hybrid loans are for people who don’t know whether to choose between SIBOR and SOR. So the bank just adds the two rates together, divides them by two, and gives you the average – that’s your interest rate.

As a crude example: if the SIBOR rate is 1.9 percent and the SOR rate is 2.1 percent, your loan would have a rate of two percent (may not be exactly the case, as some banks calculate it differently).

The theory behind hybrid loans is that, because SIBOR and SOR rates move in tandem (when one rises or falls, the other tends to follow), the lower of the two rates will pull down the higher one. If SIBOR is higher, then having SOR in the mix will pull down the interest, and vice versa.

Does it work for you? Well it depends on what the SIBOR and SOR rates are like at present, and the divergence between the two. Get an independent mortgage broker’s advice before committing to it.

5. Loans with unusually long interest rate periods

The interest rate period is given in front of the SIBOR or SOR quote. For example, a three month SIBOR means the interest rate changes every three months. A one month SIBOR means the interest rate changes every month.

The vast majority of property loans use either one month or three month interest rate periods. On some rare occasions though, you might see super long interest rate periods – nine month SIBOR or 12 months SIBOR, for example.

The main appeal of long interest rate periods is that monthly payments are consistent. This can help with personal financial planning. The other appeal is when interest rates are rising: when the American Federal Reserve announced interest rate hikes in 2015 (which would cause SIBOR and SOR to rise) many home owners demanded for longer interest rate periods. That’s because the longer interest rate period “locks in” a lower rate for a longer time.

However, a longer interest rate period often means the bank’s spread is higher. You will end up paying a premium, in order to effectively freeze the interest rate. If you want something like a 12 month SIBOR, it’s important to check and compare the price of fixed rate loans: a loan option with a one year fixed rate is just as good as that, and may be cheaper.