When it comes to mortgage loans, we have a lot of financing options. But the question is: Which one is the best for us? The answer depends on several factors, including the type of loan we want and how long we plan to hold onto it. With 11 years of experience under his belt, Alvin Lock has worked with the most prestigious local and international financial institutions in Singapore. His expertise lies in retail and private banking space, including investment advisory, legacy planning and property loans. In this article, he will explain what “floating rates” are and whether they’re still a good option for today’s home buyers.
Home buyers and property investors should consider floating rates if:
- They have a certain level of understanding for financial markets in interest rate trends.
- They are of the view that floating rate options can offer potentially significant savings compared to fixed-rate loan packages.
- There are suitable features available within floating rate options to help them better manage their loans.
Understanding the Market and Floating Rates
When a potential home buyer, or property investor chooses a floating rate option, their interest rate will not be fixed for at least, the first 2-3 years. Instead, it will change in accordance with the reference rate that is pegged to the package, in addition to a spread or margin, to form the total loan rate.
Since many of these reference rates are either highly correlated to other rates in the global market, or are subject to change at the bank’s discretion, they tend to provide significant interest savings during a typical downturn market but can increase rapidly when prices in general are rising, such as the current global inflationary climate that we are all experiencing.
Should the latter occur, home buyers must be prepared to stomach higher interest costs and still be able to afford their higher monthly loan repayments as a result of the rise in interests, and property investors alike must be prepared that their return on investments and cash flows may be adversely affected as well.
These are the common reference rates found in today’s financing packages:
SORA Rate: Average rate of overnight Singapore dollar borrowing transactions by banks in Singapore. It is a highly transparent rate and has a correlation with the US federal reserve interest rates.
Fixed Deposit Linked Rate: This is the same interest rate that banks pay their fixed deposit customers for certain deposit amounts and tenures.
Board Rate: Simply a bank managed rate, and the bank has full discretion on how and when they want to change it.
Let’s look at the lowest rates available for both fixed and floating rates based on different loan amounts as examples. Please note that these rates and packages are still available at the time of this writing but may change or expire at a later time.
For a $1,000,000 loan
Lowest fixed rate: 2.75% fixed for first 2 or 3 years
Lowest floating rate: 1.75% linked to board rate for first 2 years or 1.77% linked to SORA rate first 3 years
For a $500,000 loan
Lowest fixed rate: 2.75% fixed for first 2 or 3 years
Lowest floating rate: 1.85% linked to board rate for first 2 years or 1.87% linked to SORA rate for first 3 years
As observed from the above examples, there is an almost 0.90% to 1.00% difference between the lowest fixed and floating rates available for the 2 example loan amounts.
Which also means that if these differences remain largely unchanged, the annual dollar value will approximately be about $4,500 (difference in interest payable) for a $500,000 loan, or almost $10,000 for a $1,000,000 loan, discounting some reduction effects as a result of amortization.
For many owners including myself, such dollar differences are significant. Hence, we will need to research, and/or discuss these options extensively with our mortgage advisors to decide how viable it will be to our medium/long term management of our property/home financing.
Especially if there is/isn’t a real possibility that these interest differences may be closing up (or not) in the face of inflation or even an impending recession (or stagflation, a combination of both).
Additional Features in Loan Packages
When deciding which loan package to choose, additional features and important clauses embedded are often overlooked. Here are some current features (again at the time of this writing) available in some floating rate packages which may be helpful and suitable when managing our loans:
Shorter Lock-In Period: Some current floating rate packages offer short lock-in period of only 1 year, as compared to the longer period required for fixed rate packages of at least 2, if not 3 years.
A shorter lock-in period will allow us to have more flexibility to decide after the expiry of the period on what we would like to do for our loan and property. This is ideal for clients who have near term plans of wanting to sell their property, or would like to pay down on their loan, or to restructure the loan or the ownership of the property, or simply have the freedom and option to decide the next best option for their refinancing, without having to pay a hefty penalty if they were to be otherwise still stuck in a lock-in period.
Free Conversions: Most packages for both fixed and floating rates, do come with a free package conversion to entice owners to keep their loans with their existing banks.
However, some floating rate packages go one step further to offer free conversion anytime during lock-in period, or the conversion is available for use once the loan rate rises.
This can serve as a reprieve for some of us who may wish to change our mind and switch to something else available at that time. If a more suitable package comes up within the free conversion offers, such features will enable us to benefit from these opportunities.
Interest Offset Accounts: Such accounts, if available are features within certain floating rate packages (never for fixed rate packages), will allow a portion of our cash deposits to accrue at the same interest rate as our floating rate package.
The interests accrued will then be used to offset part of the loan interest chargeable. Therefore, more of our monthly instalments can then be re-channelled towards paying down on our outstanding loan amount.
In essence, our effective total loan rate will be lower as a result of the offset. How much lower this effective rate will be, depends on how much deposits and for how long we can hold them in such accounts.
That said, there is usually no holding period for the deposits in an interest offset account. Hence, there are no fees, no penalties, and no minimum deposit amount required to maintain these accounts.
Very ideal for business owners, or investors, or anyone who simply has some cash or deposits pending future deployment or use, that’s otherwise sitting inside a low interest-bearing savings/current account now.
Conclusion: So Fixed or Floating Rates?
It’s harder to try and predict the future now than ever before, but it’s important to be aware of how interest rates affect the cost of your mortgage and other loans. Floating rate loan packages are options we should consider when financing our home purchases or refinancing our existing mortgages because we can potentially keep our monthly payments low and pay much lesser interest than as compared to fixed rate alternatives. However, these may depend on our market views, and actual market conditions that can influence interest rate movements and behaviours, and our understanding on how the many different packages are available, together with additional features, can best serve our financing purposes.
Peace of mind may very well come with a much higher premium (to pay) today, so we hope this article has helped shed some light on what floating rates are. Most importantly, to help all of us make more informed and better decisions for the financing entirety of our home/property ownership.