Published July 9, 2009

Making sense of housing loans

Can't tell your Sibors from your SORs? Get a quick primer here


SENTIMENT seems to have made a 180-degree turn in the property market in recent months with buyers coming out in force as the economic outlook stabilises. Sellers have been known to up asking prices by 10 per cent or more. Some home buyers who were taking a wait and see attitude a few months ago rushed in to buy properties.

But before you join the rush, remember that buying a property is a long-term commitment. Make sure you can comfortably service your mortgage by capping your debt-service ratio at 35 per cent of your gross income. On top of that you should set aside enough funds to service at least six months of your housing loan instalments. This would provide some buffer should you suffer a pay cut or job loss.

Home buyers might also want to take note that supply of homes should be ample, going forward. Between 2009 and 2013, a total of 55,838 condo units are expected to be completed, according to numbers from the Urban Redevelopment Authority (URA). The supply more than meets the average demand of about 8,000 units a year.

Some developers are offering an interest absorption scheme (IAS), where the developer helps the buyer pay the interest on the housing loan while the property is under construction. Of course, such a scheme typically raises the sale price by 2 to 5 per cent, so there really is no free lunch.

Also, note that housing loan packages tied to the IAS generally charge higher interest rates. The difference can be 0.5 per cent or more. And because the IAS is offered by a single bank, taking it means losing the freedom to shop around for the best loan package. So you could forgo savings in interest of several thousand dollars.

Under the IAS, only the interest is paid while the principal outstanding is not reduced. Thus, when your property is completed, your housing loan outstanding will be higher than that of someone who has been making progressive payments.

Lastly, should the developer get into financial difficulties, the buyer is still liable to the bank for the interest on the housing loan.

Short loan tenor vs long loan tenor

Some people choose to pay off their housing loan as quickly as possible to save on interest payments. On the other hand, there are people who want to stretch the loan repayment period to the maximum so they have smaller monthly cash outflows.

Instead of going to either extreme, you could consider matching the loan tenor to your intended retirement age. For instance, if you're 40, you can take up a 20-year loan that will be paid off by the time you retire at 60.

Interest rate outlook

Sibor or the Singapore Interbank Offered Rate is the average interest rate at which banks lend or borrow local dollars from one another in Singapore. The two main factors that affect Sibor are the United States Federal Reserve rate and liquidity, or availability of funds, in the local banking sector.

The US Federal Reserve has maintained interest rates at 0.25 per cent, a historical low. Sibor has stayed slightly below 0.7 per cent in the past six months and is likely to remain there as long as US interest rates are low and liquidity here is ample.

If you want certainty of interest rates for the next few years, then go for a fixed-rate housing loan, which can be as low as 1.5 per cent for the first year.

So what is the difference between Sibor and SOR? The latter stands for the Swap Offer Rate, which comprises the Singapore Interbank Offer Rate plus market reserve costs. It represents the average cost of funds used by banks in Singapore for commercial lending.

Swap also accounts for the exchange rate of the US$ vs S$. Thus, SOR tends to be more volatile than Sibor. If you want lower volatility, go for a loan pegged to Sibor rather than SOR.

Should you aim to be debt free as soon as possible?

Most personal finance books recommend that you should aim to be debt free as soon as possible. In my opinion, as long as you have not overborrowed, you can plan to pay off your housing loan by the time you retire.

If you think about it, a housing loan is the cheapest loan on the market. In Singapore, the interest rate on a housing loan is currently about 2 per cent, while a car loan is about 4 per cent, a renovation loan 7 per cent and a credit card 24 per cent!

So it is difficult for people to fail to beat housing loan interest rates. Why? Imagine that you know nothing about investing. Just putting money into endowment savings plans gives you annual returns of about 4 per cent over a 20-year period.

Say a person has a $200,000 housing loan to be repaid over 20 years. Assuming an interest rate of 4.5 per cent on the loan, the total interest paid over 20 years is only $105,515.

If he has $200,000 in cash or CPF savings and uses this money to earn a yield of 3.5 per cent, in 20 years, he would have earned $168,453!

Most people forget that interest on a housing loan is calculated on a reducing balance basis while savings compound (interest is added on interest).

Thus, you can get ahead financially if you focus on making your cash or CPF funds work harder for you than by trying to pay off your housing loan as soon as possible.

To get an unbiased view of the housing loan packages offered by banks, you can talk to an independent mortgage broker. After all, bank officers can only offer packages from the bank they work for.

Typically, the service offered by a mortgage broker is free as they are paid separately by the banks.

Dennis Ng is a certified financial planner with 16 years of bank lending experience. He founded mortgage consultancy in 2003