Fixed rates, SIBOR, FHR18 or HDB housing loans?

Over the last year or so, I received quite a handful of emails and messages from readers on the subject of home loans. I think this blog post is probably overdue.

The banks can come up with fancy acronyms or names for their offers but there are basically two types of home loans: fixed rate or floating rate.

This is my take:

Fixed rates are for people who want to have a higher level of certainty and are quite happy with the lock in period. 

Floating rates are for people who wish to have the flexibility that comes from not having any lock in period.

I believe that which option we choose should depend on our circumstances, our beliefs and, hence, our strategy.

I choose a floating rate home loan pegged to the 1 month SIBOR (+ 1%) because I believe that I have the resources to pay down my home loan rapidly if interest rates should spike. 

For example, when interest rate on my home loan spiked to 5.1% many years ago, I chose to pay down the loan for my previous home. 

5.1%? Yes, I know this might look unbelievable to younger readers but ask the older folks and they should remember and, for some, it might have even been higher.

However, if I did not have the resources to pay down my home loan, I would have been stuck with the relatively high financing cost. 

I was not eligible to re-finance my home loan as the quantum was lesser than $200K by then. Banks weren't interested in refinancing relatively small loans.

This was a chat I had recently with a reader:

• Reader: Hi Ak, are you able to update on your home loan vs bank loan blog. Do you think is advisable to get dbs bank loan. 1st year fhr18 + 0.4%, 2nd year onwards, fhr18 + 1.2%. Lock in for 2 years. Cpf is still 2.6%.
• 
  
• 

  11:16am
  

  Assi AK

  Sounds like a good deal. The worry is the FHR18 and how high it could go but interest rates are likely to stay low for a while.

  
  
• 11:21am
  

  Reader:
  

  
  

  
  

  I read your blog about paying home loan within 10 year. Lower interest. Is there a ideal year that we should finish our loan

  
  

  Number of year. Or a formula we can used
• 

  11:23am
  

  Assi AK

  10 years was because the fixed rate would end by then.

  
  

  It was an offer by POSB.

  
  
• 11:23am
  

  Reader:
  

  
  

  
  

  That offer ended. So this is the current promotion. I hope it wouldn't go up more than 2.6 percent
• 

  11:25am
  

  Assi AK

  The first 2 years, you are probably safe but the FHR is floating. So, in the 2nd year, if it does not go to 1.4% or higher, you are safe. Further along the road, it would be harder to say.
• 11:26am
  

  Reader:
  

  
  

  
  

  So in the other words. Hdb will be a better opinion
• 

  11:31am
  

  Assi AK

  Nope. I didn't say that. ;p It depends on our strategy, our circumstances and our beliefs. If we have the resources or are actively preparing the resources to be able to pay down our home loan rapidly in the event interest rates spike up, then, bank loans with the lower interest rates now are viable options to consider. Why not? Remember that once we opt for bank loans, we cannot go back to a HDB home loan.

  
  

The offer made to the reader by DBS here is pretty interesting because it is a floating rate with a lock in period of 2 years. Floating rates don't usually have a lock in period. 

What's the catch?

If the FHR18 should spike in these 2 years, bad luck, although it seems unlikely that it would.

What is FHR18?

The FHR18 is basically the interest rate on an 18 months fixed deposit offered by DBS. This is currently at 0.6% per annum. 

So, in the above example, first year interest rate is effectively 1% and for the second year and beyond, effective interest rate is 1.8% as long as the FHR18 stays unchanged.

There are debates on whether using the SIBOR (1 month or 3 months) plus a spread is better or whether FHR18 plus a spread is better. Central to the debates is the matter of transparency with the FHR18 being the winner. 

However, to me, what is more important in the decision making process apart from getting a good deal is to consider our circumstances and what we are able to do in the event that interest rates should spike. 

I always say that we cannot predict but we can prepare. If we are prepared, all is good. Peace of mind is priceless.

Related post:
POSB HDB Loan: Peace of mind.