Explain how fixed, floating and SORA-pegged packages set the rate you pay.
When you're handed a mortgage package, the big number at the top is only part of the rate. Every package sets its rate in one of a few ways, and the headline figure only describes the first of them. To compare packages fairly, you need three rates for each one: the rate now, the rate if the benchmark rose by one percentage point, and the rate after any fixed period ends. Once you have those written down, you can compare packages on the same terms and see what each one is betting on.
A fixed package holds the interest rate for the first few years of the loan. MoneySense, the national financial literacy programme, describes this as a rate that is fixed and will not change for the first few years. Check the offer letter for how long your package's fixed period lasts. During that period your instalment does not change, whatever market rates do. You pay for that certainty. Fixed rates tend to be higher than floating rates when markets expect rates to rise, and they can be lower than floating rates when markets expect rates to fall.
The fixed period ends long before the loan does. After it, the package switches to a floating rate, which the offer writes as "thereafter". The thereafter rate is what you pay if you do nothing, so it belongs in any comparison. Lesson 8.1 in "Read the fine print: payslips, statements, policies and contracts" shows where to find the thereafter rate in an offer letter.
Most floating packages are pegged to SORA, the Singapore Overnight Rate Average, which MAS publishes. A SORA-pegged rate is the benchmark plus a spread, which is the margin the bank adds on top. The spread is kept for the life of the package or changed on a schedule written into the offer. The benchmark is usually a compounded SORA over one or three months, such as 3M SORA. SORA looks backwards: it averages the overnight rate over the past period. Your rate is reset each period to reflect what rates just did, so if SORA rises, your rate rises at the next reset, and so does your instalment. Lesson 2.2 of "How the economy hits your wallet: rates, inflation and cycles", "What SORA is and how it ends up in your mortgage", explains why SORA moves. To compare packages you only need the arithmetic.
A board rate is a rate the bank sets itself and can change whenever it chooses. The offer letter usually does not say what would trigger a change. A board rate package may look cheap today, but you cannot check how it is set or predict it from published figures. A SORA peg is easier to watch because SORA is published and the spread is in the contract. With a board rate, you rely on the bank's choices. Some buyers accept a board rate in exchange for a lower starting rate. Whichever you choose, know which kind of package you have.
Farah and Hakim are taking out a S$427,000 mortgage over 25 years (an invented example). Their mortgage broker sends them three bank packages in one message (also invented):
Package 1: "2.50% fixed, 2 years" Package 2: "3M SORA + 0.30%" Package 3: "2.35% fixed, 3 years, thereafter 3M SORA + 1.20%"
Hakim's first instinct is to pick the lowest headline number, 2.35%. Farah points out that this rate lasts only three years of a 25-year loan.
To test the packages, take 3M SORA as 2.40% (a figure invented for this example). The instalments below are for a standard repayment loan of S$427,000 over 300 months.
Package 2 is pegged from the start. Today its rate is 2.40% + 0.30% = 2.70%, which gives S$1,958.89 a month. If SORA rises by one percentage point to 3.40%, the rate becomes 3.70% and the instalment becomes S$2,183.74. The difference is S$224.85, or about S$225 more every month, from a rate Farah and Hakim don't control.
Package 1 is 2.50% for two years, at S$1,915.59 a month. Because the rate is fixed, the instalment stays the same for those two years even after a one-point rise. The headline says nothing about what comes after, so they ask the broker, who tells them the thereafter rate is SORA + 1.00%. That makes 3.40% at today's SORA and 4.40% after the rise.
Package 3 is 2.35% fixed for three years, at S$1,883.50 a month, and a rise in that period does not affect it. Its thereafter rate of SORA + 1.20% works out to 3.60% now and 4.60% after the rise.
Package 3 has the lowest early rate and the highest rate after its fixed period. This is a common pattern: the packages with the lowest early rates often have the highest rates later. Banks expect many borrowers to reprice or refinance when the lock-in ends, so they price for the borrowers who don't. Lesson 8.1, "Reprice or refinance when the lock-in ends", covers what to do at that point instead of staying on the thereafter rate.
First, identify how the package sets its rate: fixed, SORA-pegged (benchmark plus spread) or board rate. For a SORA peg, add the spread to the current benchmark, such as 3M SORA, to get today's rate. Then add one percentage point to the benchmark to get the rate after a rise. A fixed rate stays the same during its fixed period.
Next, find the thereafter rate in the offer letter. If it isn't in the headline, ask for it, as Farah and Hakim did. Work it out at today's benchmark and at the benchmark plus one point. Convert the rates into monthly instalments using your loan amount and term, so you can compare the packages in dollars.
For each package you should end up with three numbers: the rate now, the rate after a one-point rise, and the rate after any fixed period. These numbers show which bet you are making. A fixed package bets that certainty is worth paying a little extra for. A floating package bets that rates won't rise much while you hold it.
Farah and Hakim's broker sent three packages, but for the activity below you need just two of yours: one fixed and one floating. For each, write down its rate today and its rate after a one-point rise in the benchmark.
Take one fixed and one floating package. Write the rate each charges now and what it would be if the benchmark went up one percentage point.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).