Because home loans aren’t confusing enough, banks offer two different kinds of interest rates. We’re talking about fixed and floating home loans, and how to pick the one that best suits you. So if you’re looking to buy a house in Singapore or intend to anytime in the future, then have a read of this handy MoneySmart guide.
Fixed Rate Home Loan:
Fixed interest means that you and your bank agree on a set interest rate. After that, the interest rate on your house doesn’t change for a specified duration.
Because the bank has to guarantee your interest rate regardless of the market situation, you will pay a premium. This premium is added onto the existing rate. For example, if the existing rate is 0.8 percent, and your premium is 0.4 percent, then you would pay 1.2 percent interest.
The fixed interest lasts for a specific duration, usually one, three, or five years. Many banks also set terms that allow them to change the fixed rate, under reasonable circumstances (you pay late, there’s been an epic financial collapse, you hum Justin Bieber songs in public, etc.)
Floating Rate Home Loan:
A floating rate is a variable interest rate, usually based on the Singapore Interbank Offered Rate (SIBOR) or Singapore Swap Offer Rate (SOR).
To put it plainly, SIBOR and SOR are measurements of how the banks are lending to each other. A floating interest rate means that your interest is pegged to one of these two indexes. Depending on the index, your interest rate will go up or down each month. You can find the more technical details here.
Certain banks may use an internal board rate (IBO) instead of SIBOR and SOR. That means their rates vary based on how much they’re lending, how much they’re earning, operational costs, and whether a disgruntled CFO had an acute case of constipation that morning.
Whatever the index they use, it means the same thing: floating interest rate is like a big, expensive yo-yo.
Why Go For a Fixed Rate?:
- A fixed rate means you can plan your cash flow better. You know how much you can afford to spend each month.
- You don’t need to execute your range of mortifying good-luck dances before opening your bills. It’s going to be the same as last month.
- You may have reliable information that market rates are climbing.
Why Go For a Floating Rate?:
With few exceptions, a floating rate is cheaper in the long run. That’s because of the hefty premium that comes with a fixed rate. An example:
Say the average rate is 1.2 percent, when you get your loan. Everyone on a floating rate is paying that, but you’re paying 1.7 percent because yours is fixed.
Now let’s say there’s a spike in the market. It’s rarely more than another 0.5 percent (in either direction). So when the rate climbs, the people on a floating rate end up paying 1.7 percent, which is comparable to you. The difference is that when it dips back down, they get to pay 1.2 percent again, while you’re still stuck at 1.7 percent.
If a fixed rate is only going to last a few years years, it’s probably not worth paying the premium for that short period of security. And with very rare exceptions, fixed rates will last five years maximum.
- Check the bank’s base rates over the past two or three years. See if they really lowered their rates to match the market.
- It’s theoretically possible that you’ll find a fixed rate which lasts for the whole loan. Check if the banker’s eyes are glowing red, or if your immortal soul is mentioned in the contract. Otherwise, check again to be sure you haven’t misunderstood a promotional gimmick.
- Compare the rates from different banks. Spend some time reading up on them, and make sure you’re comfortable with the deal.
- If you have a floating rate, you need to keep track of the changes. Some banks may not inform you of the exact changes, until you ask or check yourself.
Summary: Which is better?
At the end of the day, there’s no right or wrong answer. It’s all about your personal preference and you appetite for risk. If you think that the market outlook doesn’t look so good over the next 3 years (i.e. interest rates will remain low), and your fixed rate option is significantly higher than the floating rate one, we’d recommend you go for a floating rate home loan.
If you think that rates are likely to go up significantly past the fixed rate mark. Then you should take up a fixed rate home loan.
Visit MoneySmart to check up on the latest fixed and floating interest rates offered by banks in Singapore.
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If you recently took up a home loan, we’d love to hear what you picked and why in the comments below!