Finding The Best Way To Pay Off A Home Loan

Source : The Sunday Times, August 24, 2008

Choosing a suitable home loan package can be daunting with the myriad of choices available to a home owner. Invest looks at the current refinancing trend and highlights two new loan packages

When the going gets tough, the tough go shopping. And that is what home owners have been doing - shopping for suitable and the lowest home loan rates.

The cheap cost of borrowing, a result of interest rates heading south, has led to more home owners opting to refinance their mortgages to enjoy savings.

Fuelling this trend are financial institutions which are jumping on the bandwagon to launch attractive and creative loan packages to capture a bigger slice of the lucrative mortgage market.


Refinancing your home loans

Let's take a look at the refinancing trend so far this year. Mortgage consultancy portal www.HousingLoanSG.com has seen a surge of at least 50 per cent in refinancing activities.

At HSBC, the volume of refinancing applications has grown more than 50 per cent in the last three months.

'The reason for this trend is the big drop in the Singapore Interbank Offered Rate

(Sibor) in the last 18 months from as high as 3.5 per cent to about 1.2 per cent currently,' said Mr Dennis Ng, spokesman for www.HousingLoanSG.com.

Sibor is the benchmark rate used by banks to determine mortgage rates for home loans. It is the cost at which banks borrow funds from one another.

The drop in Sibor means that those who took up a housing loan one to two years ago are likely to enjoy significant interest savings if they refinance now.

Mr Ng worked out that refinancing an outstanding loan amount of $480,000 to a lower interest rate of 1.95 per cent, down from the current rate of 3.5 per cent, will result in interest savings of $21,710 over three years. This assumes a 25-year loan tenure.

Even those who are subject to lock-in and clawback penalties may save money by refinancing, said Ms Annie Lim, managing director of mortgage consultancy Global Creatif Financial.

Furthermore, financial institutions which are eager for your business may offer to pay your legal fees of up to $2,000 for you to switch banks.

Refinancing has represented 75 per cent of all mortgages at Global Creatif Financial so far this year.

Still, Ms Helen Neo, Maybank Singapore's head of consumer banking, cautions that refinancing should be considered only when there are no plans to sell the property in the short term so as to avoid paperwork and potential costs.


Pegged rates versus fixed rates

With Sibor falling steadily, it is not surprising that many customers are opting for new Sibor-linked packages or refinancing from a fixed-rate package to a Sibor one.

Still, some customers are confused when faced with a choice of a three-month or a 12-month Sibor-pegged home loan package.

Mr Ng noted that if one chooses the latter, it is as good as fixing the interest rate for a year.

This means the customer enjoys greater certainty or lower volatility with a 12-month Sibor package than a three-month package.

However, as the 12-month Sibor rate is typically 0.5 per cent higher than the three-month Sibor, he will end up paying a higher interest.

Ms Lim believes that the three-month Sibor will appeal to those who are comfortable with the current interest-rate environment and who expect rates to stay depressed.

Looking ahead, Mr Bryan Ong of mortgage consultancy bcgroup.com.sg thinks that rates will remain flat for the next 18 months. That is why he feels that the three-month Sibor is 'the way to go'.


New home loan packages

With depressed interest rates and an influx of new and creative home loan packages, home owners are spoilt for choice.

However, opting for the cheapest rates may not always be the best for every home owner, as different people have different needs.


# MortgageOne Sibor

For instance, Standard Chartered Bank's (Stanchart) newly launched MortgageOne Sibor will appeal to those with excess cash.

This is because it comes with an offset feature so that customers can use the interest earned on their deposits to reduce the interest payable on their home loans.

MortgageOne Sibor loans are priced at 0.8 per cent per annum above the three-month Sibor for the first three years.

Customers can enjoy the same interest rate as their mortgage loan on two-thirds of the deposits linked to their loans, subject to a maximum of their outstanding loan amount. The remaining deposits will enjoy an annual rate of 0.5 per cent.

At the same time, they have the flexibility to withdraw their deposits at any time.

'This is good for home owners who have surplus cash. They could be waiting for investment opportunities and want to remain liquid. In the meantime, they can use their cash to reduce their loans,' said Mr Ong.


Interest-only loans

Some mortgage packages like the DBS Bank's new interest-only mortgage product launched early this month appear attractive, but experts cautioned that they are not suitable for everyone.

The product allows customers to pay only the interest for the entire duration of their home loan.

The principal amount is payable in one lump sum only at the end of the loan tenure.

This means that the money that would otherwise have formed the principal component of the loan instalments would be available to the customer for investing.

Ms Lim worked out that based on a rate of 3 per cent, a $1 million loan with a 25-year tenure would have a monthly instalment of $4,486.

Of this, $2,083 is paid towards the principal and would thus be available to the customer to meet other needs if he opts for interest-only servicing.

But here's the potential pitfall. If the customer invests wrongly or, worse still, has no discipline to save and invest, the amount would be frittered away and he still has a loan to pay.

Ms Lim said that she would go for an interest-only loan only under the following situations:

# If she has an intention to buy multiple properties and would like to pay only the loan interest and keep every cent possible;

# If she has other alternatives to invest at higher returns; or

# If her cashflow is very tight.

Like her, most experts said that they would prefer the conventional packages where both principal and interest are paid up regularly and doing so helps them pay their home loans in a disciplined manner.

Said Mr Ng: 'The customer might end up in financial trouble in the event that property prices correct by say over 20 per cent and plunge him into negative equity.

'In such a situation, he might not be able to sell his property at a price where he can pay up the loan.'

He cautioned home owners who opt for such a product that they would end up paying more interest in the long run compared to conventional loan packages where both the interest and principal components are paid up regularly.

However, Mr Ng added that he might consider such a loan package if he is buying an investment property.

DBS' interest-only mortgage charges 1.5 per cent on top of either the three-month or 12-month Sibor.

Other banks like Stanchart allow customers to pay only interest on a mortgage for up to three years and such products are offered on a case-by-case basis.

To ensure that customers are not overstretched, DBS imposes certain restrictions such as allowing home owners to borrow only up to 70 per cent of the property purchase price.

Finally, Stanchart's general manager of lending, Mr Dennis Khoo, advises home owners to consider the following when choosing a mortgage package:

# Is the property for your own stay or for investment?

# What are your long-term financial goals?

# Do you prefer security and protection or transparency with some volatility?

# Do you have any spare cash that you can use to reduce your interest payments and shorten your loan tenure?


A word of caution

'The customer might end up in financial trouble in the event that property prices correct by say over 20 per cent and plunge him into negative equity. In such a situation, he might not be able to sell his property at a price where he can pay up the loan.'

MR DENNIS NG, spokesman for www.HousingLoanSG.com, on the dangers of taking up an interest-only loan