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So, you’re buying a new house. And you’re taking a home loan (some people like to call it mortgage, too). Now, you’re overwhelmed with finance lingo that sounds like interest rate, fixed, floating etc.
It’s too much to take in. Yet, know that you’re not alone. This confusion is a rite of passage all homeowners have been through. Let’s tackle this together.
What is interest rate (in home loans)?
An interest rate on a home loan, often just called a mortgage, is essentially the cost you have to pay when borrowing money from the bank (or HDB).
When the HDB or a bank lends you a large sum of money to purchase a house, they aren’t doing it for free; they charge you a fee for the privilege of using their money over a long period of time (usually 20 to 25 years!).
This fee you pay is called interest, and the way you calculate how much you have to pay (the interest rate) is expressed as a percentage of the principal amount you borrowed. For example, HDB Loan’s interest rate is 2.6%.
Lower interest rate is better
This interest you pay is the bank’s profit! For instance, if you borrow $500,000 at a 4% interest rate, you are required to pay back the original $500,000 (called the principal) plus the calculated interest over the years of your home loan.
So the interest rate really matters! You don’t want to let the bank earn so much of your money. Also, we usually take home loans over a long 20 to 25-year duration. Which means the bank will be earning your money for 20 odd years!
When a home loan is so long, the total amount of interest paid can sometimes equal or even exceed the original loan amount. That’s why you must pick a low interest rate.
What is a fixed interest rate?
Now that you understand home loan interest rate is the bank’s way of profiting, let’s talk about the two types of interest rates banks will often offer you.
For home loans, you will encounter two main types of interest rates: fixed and floating (or variable).
A fixed rate provides stability and predictability; the interest percentage remains the same for a set period of time, often two or three years, regardless of what is happening in the wider economy.
Closer to home, for example, the HDB loan comes with a fixed interest rate of 2.6% per year. How did the HDB loan’s 2.6% interest rate come about? It’s pegged to the CPF Ordinary Account’s 2.5% interest rate that you earn as savings - plus 0.1% for all their administrative fees.
This gives you peace of mind as your monthly payment won’t change.
What is a floating interest rate?
Conversely, a floating rate is tied to a financial benchmark—like the Singapore Overnight Rate Average (SORA)—and it fluctuates based on market conditions.
If the economy is booming and general interest rates rise, your floating rate will also rise, increasing your monthly payments. If rates fall, your payments decrease.
Fixed vs floating interest rate
Ok, here’s where things get choppy. Stay with me. You choose a fixed vs floating interest rate based on the wider global economy.
If interest rates are expected to rise → A fixed rate is preferable to lock in lower costs.
If interest rates are expected to fall or stay low → A floating rate may be more cost-effective.
When choosing between a fixed and floating (variable) interest rate for a home loan in Singapore, several key factors should be considered. Fixed interest rate remains constant for a set period (e.g., 2-5 years), providing predictable monthly payments.
Floating interest rate fluctuates based on market conditions, potentially leading to cost savings when rates are low but higher payments when rates rise.
Rising interest rate economy, fixed interest rate is better
Fixed interest rate mortgages are better in rising interest rate environments because they lock in the interest rate for the entire loan term, protecting borrowers from future rate hikes. Also, with a fixed-rate mortgage, your principal and interest payments remain constant, making it easier to budget and plan for the future.
If interest rates rise, new borrowers will have to pay higher rates, but those with fixed-rate mortgages continue to pay the same lower rate they locked in at the beginning. If rates drop in the future, you can refinance to a lower rate. But if rates rise, you’re already locked into a lower, more favourable rate.
Declining Interest Rate Economy: Floating interest rate is better
A flat to declining interest rate environment refers to a period when interest rates remain stable (flat) or gradually decrease (declining) over time. This is influenced by economic conditions, central bank policies, inflation trends, and overall market demand for borrowing.
In a flat interest rate climate, the central bank keeps rates unchanged for an extended period due to stable economic conditions, controlled inflation, and balanced growth.
In a declining interest rate climate, interest rates decrease when economic growth slows, inflation falls, or central banks cut rates to stimulate borrowing and investment.
Floating interest rate mortgages then become more attractive because their rates can decrease over time, reducing monthly payments. Fixed-rate mortgages may be less appealing since rates could drop further, allowing better refinancing opportunities in the future.
Therefore, it is also generally better to get a floating rate loan in a flat interest rate environment. Banks will charge you higher interest rates on fixed-rate loans from the certainty of knowing exactly how much to pay each month.
Low Interest Rate
In a low interest rate environment, a floating interest rate mortgage is generally more attractive.
A low interest rate environment is a period when interest rates are at historically low levels, often due to economic policies aimed at stimulating growth. Central banks, like the U.S. Federal Reserve or the Monetary Authority of Singapore (MAS), typically keep rates low to encourage borrowing, investing, and spending.
In a low interest rate climate, borrowing becomes cheaper. Loans, mortgages, and credit lines become more affordable. Savings accounts and fixed deposits offer lower interest rates, making it less attractive to keep money in cash. However, when lower interest rates make borrowing cheaper, it often drive up real estate and stock market prices.