You will be able to read the rate section of a loan offer and say how and when the rate can change.
Jason and Mei, both 34, are buying a resale condo in Sengkang. Their mortgage broker sent two bank offer letters for a S$600,000 loan over 25 years, each about ten pages. On the phone the broker summed them up in one line each: "Offer A is 2.6% fixed, Offer B is SORA-pegged and a bit cheaper." Mei opened Offer A and found the 2.6% on page two, in a table that ran for three rows. The third row didn't say 2.6%. It said something about SORA plus 0.8%, "thereafter".
A loan's rate is rarely one number. It's a schedule, and the offer letter sets out how the rate is worked out in each period and what it can change with. This lesson shows you how to read that section, so you can say how and when the rate on any loan offer can change.
A fixed rate stays the same for a set period, commonly the first two or three years of a home loan. Your instalment stays the same during that period, whatever happens to interest rates generally.
The fixed period almost always ends before the loan does. After it, the loan usually moves to a floating rate, and the offer letter says which. That's what the "thereafter" row in Offer A was telling Mei. The 2.6% applied to years one and two. From year three, the rate would float.
So when you read a fixed rate, always read the line below it. The question isn't only what you pay now, but what you'll pay when the fixed period ends, because for most of a 25-year loan, that's the rate that applies, unless you refinance.
A floating rate has two parts. The first is a benchmark, a reference rate the bank doesn't control. The second is a spread, a fixed margin the bank adds on top, stated in the offer letter.
In Singapore, the common benchmark for home loans is SORA, the Singapore Overnight Rate Average, which MAS publishes. Loans usually use a compounded version of it averaged over one month or three months, and the offer letter says which one and how often your rate resets. When the benchmark moves, your rate and your instalment move with it.
Offer B was "3M compounded SORA plus 0.5%" for the first two years and plus 0.8% after that. Suppose, purely as an example, compounded SORA were 2.0%. Offer B's rate would be 2.5% in years one and two, and 2.8% from year three. If SORA rose to 3.0%, those would become 3.5% and 3.8%. The spread is what the bank fixes. The benchmark is what moves.
Some floating rates use a board rate instead. A board rate is set by the bank itself, and the bank can change it. That gives you less to check it against than a published benchmark, so read the offer letter for how the board rate is set and how much notice you get of a change.
Other packages peg the rate to the bank's fixed deposit rate or to another reference. Whatever the peg, find out who sets it and where it's published.
The rate table in an offer letter often steps up over time. A low rate in year one, a slightly higher one in year two, and a higher spread from year three is a common shape. Read every row. Write the rate, or the formula, for each year shown, and note what applies after the last one.
Jason and Mei's notes looked like this. Offer A: 2.6% fixed in years one and two, then 3M compounded SORA plus 0.8% thereafter. Offer B: 3M compounded SORA plus 0.5% in years one and two, then plus 0.8% thereafter. From year three the two offers were identical, so the only difference in rate was the first two years, where a fixed 2.6% faced a floating rate that would start at 2.5% with the example SORA of 2.0% and could then move either way.
That was a much smaller difference than the broker's one-liner suggested. What separated the offers was a choice between certainty and a possible saving. Lesson 8.4, Compare two loan offer letters, turns the comparison into instalments.
Home loans quote rates on the reducing balance, so the rate in the offer letter is the one your interest is worked out on. Personal loans and car loans often work differently, because they're frequently quoted at a flat rate that charges interest on the original sum for the whole term.
As lesson 3.2 of How money works showed, Why a flat rate loan costs nearly double what it looks like, a 3% flat rate on a five-year loan works out at about 5.6% on a reducing balance. So for these loans, compare offers on the effective interest rate, the EIR, which includes the effect of fees as well as the flat rate. Lenders show the EIR in their offers. Use it, not the headline rate, when you put two offers side by side.
The offer letter you read for the activity can be any loan, but read its rate section the way Jason and Mei did, one year at a time.
For one loan offer, write the rate for each year shown, what it is pegged to and when the rate becomes floating.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).