Tuesday, September 16, 2014

Housing loans - What to choose and what happens to your loans when interest rates goes up?

There are many loan packages to choose from when you buy a house in Singapore. HDB provides concessionary interest rate to eligible flat buyers at 0.1% above the CPF ordinary account rates. It is currently at 2,6%. But, with the low interest rates environment, banks are offering very attractive low interest rates packages from as low as 1.5%. That is 1% lower than the HDB loans that is being offered. However, low interest rates may not be a good thing. They are most likely associated with variable interest rates packages or floating rates packages. What happens to your loans when interest rates goes up?

2 types of loan packages

Before we look into what happens if interest rates goes up, let's take a look at 2 typical types of loan packages offered by the banks. The first is short term fixed interest rates and the second is variable interest rates and SIBOR dependant rates. There may be other packages offered by foreign banks but let's focus on the local banks in Singapore here first.

Short Term fixed interest rates

I've check on the local banks in Singapore and they seem to offer only short term fixed rates packages. For POSB, its 5-8 years fixed. For UOB they do not display their packages. For OCBC they only offer fixed rates for the first 1-2 years and for DBS, its similiar to POSB. Typically, the interest rates offered on fixed rate packages are higher than the variable interest rates packages.

After the fixed rates term, the interest rates will be recalculated. For OCBC, it is stated that thereafter, the rates will be based on the bank’s Board Rates minus a discount stated in the Letter of Offer. It simply means that your monthly loan repayment amounts may change after the fixed rate periods.

Variable interest rates and SIBOR dependant rates 

For variable rates packages, it can be based on the bank's board rate minus a discount stated in the letter of offer as in the case of OCBC. It can also be SIBOR dependant rates where the rates follow the SIBOR rate plus a fixed percentage. For OCBC, its 3 Months SIBOR + 1.25% throughout. So if SIBOR rates increases, the interest rate increases as well. Confusing? Not to worry, I'll explain what is SIBOR below.

What is SIBOR?

Some may ask what exactly is SIBOR? In its original form, it is called Singapore Interbank Offer Rate. This is a rate which Singapore banks lend to each other. You may have heard of the London Interbank Offer rate (LIBOR) which is used in the UK.

We can find the SIBOR rate from Monetary Authority of Singapore(MAS) website. The 3 months SIBOR is currently at 0.407. Most banks use either the 3 months or 1 month as a benchmark for their SIBOR dependant rates. So, if you take up the OCBC SIBOR dependant rate loan package, the interest currently would be 1.657% (0.407 + 1.25%). This is somewhat 1% lower than the 2.6% rate package which HDB offers.

But, we should not choose a loan package just because it has a lower interest rate. We have to take into consideration what if interest rates do increase? To do that, we need to take a look at the interest rate history in the US as well as the SIBOR

Interest rates may go up?

I manage to find a good chart illustrating the history of interest rates in the US from 1790. That was a long long time ago. From what i see, the average interest rates throughout history is about 5-6%. We're in an era of extremely low interest rates now. Will interest rates go up from here?

Credit: http://www.ritholtz.com/blog/wp-content/uploads/2012/01/Long-Term.png
Click image to enlarge

The lowest interest rates the US had was about 0.25% just last year. How about the interest rates in Singapore? We should be concern about this as it will definitely affect the loans we have to pay. Singapore normally follow the interest rates of big economies such as the US.

I only manage to find the data of Singapore's 3 months and 1 month SIBOR rates from 1987. The data was take from MAS website which I plotted into a chart.

Click image to enlarge

From 1987 till now, the 3 months SIBOR has been on a long term down trend. The reason for the decrease in interest rates is to encourage growth through spending during times of recession or crisis. As interest rates are lower, businesses and individuals can borrow more money at a cheaper rate to buy houses, cars, lands, build factories etc.

Interest rates will rise when the economy starts to pick up. This is to control the level of inflation in the economy. If interest rates do not rise by then, hyper inflation may happen which causes prices to rise at an unimaginable level.

What happens if interest rates goes up?

Interest rates are near zero now. It is a matter of time before it rises. There's no way interest rates can go any lower. Look at the time in the 1940s when interest rates were near zero also. It later went on a 30 year rise up to 14% in the 1980s. When it rises, your monthly loan repayment amount will rise as well. But, how will it affect us? Let's take a look at some scenarios.

Bought a HDB flat with $300,000 loan at 1.6%

If you've bought a HDB flat and took up $300,000 loan, your monthly loan instalment base on 1.6% interest and 25 years repayment period is $1,214 per month. This may be the sum many of you are paying for your housing loan now.

If interest rates rises to 2.6%, your monthly loan will then be increased to $1,361. That is more than a $100 increase per month. If interest rates increased further to 3.6%, your loan instalment would also increase further to $1,518. This is $200 more from the original amount you had to pay.

Do also note that the TDSR framework set by the MAS will still apply when you refinance. The TDSR means that your housing loan repayments, after adding all your repayment obligations (student loans, credit card debts, car loans, personal loans, etc.), cannot exceed 60% of your income. When interest rates goes up, the standard practice is to switch to another home loan with a lower interest. But with the TDSR, some who try to refinance may find that they don't meet the 60% TDSR which means they will be stuck with their higher interest rates home loans.

However, those who bought a residential property before the TDSR rules were introduced will be exempted. The option to purchase (OTP) must be granted before 29 June 2013. The owner will be granted exemption as long as he occupies the residential property that is being refinanced.

Be prepared for an increase in interest rates

If you're planning to take a loan or have already taken a loan for your new house, do take into consideration and prepare yourself in the event of a rise in interest rates. The rise in your loans amount would probably be in the range of $100-$200+ monthly for a $300,000 loan.

For those with even higher loan amounts, the increase would definitely be bigger. For a $500,000 loan, a 2% increase in interest rates will increase your loan amount by about $500 per month. Are you prepared for it?

HDB loan vs bank loans

The HDB loan interest rate is pegged at 0.1% above the CPF ordinary account interest rates. The rate is not fixed and may increase and decrease as well. However, as we know, the rates of the CPF rarely changes. Many people have seek for the increase in CPF interest rates but it still did not happened. Well, i hope it does not. If CPF interest rates really increases, those people with housing loans from HDB would be in trouble.

There isn't a long term fixed rate loan package in Singapore. DBS and POSB offers 5-8 years fixed rate which is probably the longest we can see. The HDB loan is also not a fixed rate loan but at least its rates doesn't changes too frequently. In anticipation for a rise in interest rates, we should look for alternatives which gives us peace in our lives. You can refinance for your current loan or choose the right loan package when buying a new house. It is still not too late to make the right decision today.

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Related Posts:
1. HDB resale prices took 10 years to recover from a crash
2. A couple should buy a 3 room HDB flat if combined gross income is less than $4000


  1. Good article, thank you for posting.

  2. Hi sir. I would like to clarify 1 issue. You mentioned that "The TDSR means that your housing loan repayments, after adding all your repayment obligations (student loans, credit card debts, car loans, personal loans, etc.), cannot exceed 60% of your income." If i repay my credit bills every month on time and have never been unable to pay my credit card bills, will this still affect how much I can borrow from HDB if i am looking to purchase a bto flat using a HDB loan?

    1. Hi,

      From what I know, your credit card balances at the end of the month will be counted towards the tdsr when you apply for your loans. However, I'm not sure how exactly the banks calculate the numbers. Check with them will be better.

  3. Anw, thank you for the informative article.