Find the lock-in and prepayment terms in an offer and work out what repaying early would cost.
Jason and Mei are buying a flat and comparing two loan offers, Offer A and Offer B. Mei's parents have offered them a gift towards the flat, to be paid once the parents sell their own place, probably within a year or so, and the couple plan to use it to pay down a chunk of the mortgage.
Repaying debt early can cost money. Many home loan offers in Singapore have a lock-in period, and the clause that sets it out decides what changing your plans would cost in the first few years. While reading Offer A, Mei finds a clause headed "Prepayment and redemption" that mentions a penalty. That clause is where Jason and Mei's plan for the gift could become expensive.
A lock-in period is a stretch at the start of the loan, often the first two or three years. If you repay the loan early during this time, in full or in part, you pay a penalty. Refinancing to another bank during the lock-in counts as repaying the loan, so it triggers the penalty too. Banks use lock-ins because they price a package expecting to earn interest on it for some time. For that reason, a low rate in the first years often comes with a lock-in.
The offer letter states the lock-in period. You'll usually find it near the rate table, or in the section on prepayment, redemption or cancellation. When Jason and Mei checked, Offer A had a two-year lock-in and Offer B had a three-year lock-in, with a lower starting rate than Offer A (both example offers). Their broker had not mentioned the difference. A difference in lock-in length matters at least as much as a difference in rate, so look for it in every letter yourself.
The prepayment penalty is a charge for repaying during the lock-in. It is usually a percentage of the amount you repay, so it grows with the amount. A small partial repayment brings a small penalty. Repaying the whole loan brings a penalty on the whole outstanding balance, and selling usually does too, unless the package includes a sale waiver clause. The penalty percentage is always stated in the offer letter.
Some offers allow partial repayments without a penalty, within limits, even during the lock-in. Others allow them only after the lock-in ends. Partial repayments usually come with conditions: a minimum amount per repayment, a period of written notice before you pay, and sometimes a yearly cap on how much you can repay without a penalty. Read these conditions as carefully as the penalty itself, because they decide whether your repayment plan works. Repaying after the lock-in costs nothing only if the letter allows penalty-free partial repayment at that point, and only if you give any notice it requires.
What happens after a partial repayment depends on the bank, so a choice between a lower monthly instalment and a shorter loan is not guaranteed. At DBS, for example, a partial repayment lowers the monthly instalment and leaves the remaining tenure unchanged. Check your letter, or ask your bank, to see which applies.
Selling is the case that catches people out. If you sell the property during the lock-in, the loan is usually repaid from the sale proceeds, and that repayment usually triggers the penalty on the full amount redeemed. Some packages include a sale waiver clause, which removes the penalty when the loan is fully repaid from the sale proceeds. If yours does, the letter will spell it out.
Offer A is a S$600,000 loan over 25 years at 2.6% for the first two years, with a penalty of 1.5% of the amount repaid within the lock-in (example figures). The gift is expected in about a year, which falls in the middle of Offer A's lock-in and early in Offer B's.
At the end of month 12, halfway through Offer A's two-year lock-in, the outstanding balance is about S$582,731. If they repaid the full balance then, the penalty would be 1.5% x S$582,731 = about S$8,741. Their actual plan is to repay S$50,000 at month 12, which costs 1.5% x S$50,000 = S$750. If they wait until month 25, after Offer A's lock-in has ended, the penalty on the same S$50,000 is S$0, provided the letter allows penalty-free partial repayment then and they give the required notice. They also check what the repayment would do to the loan: lower the instalment or shorten the term.
To find the outstanding balance at any month, use the loan's own amortisation schedule, which the bank can provide, or a spreadsheet. In Lesson 8.4, "Compare two loan offer letters", you build an amortisation spreadsheet with the PMT function, and you can use it to read off the balance at any month.
If there is any chance you will sell, move or refinance in the next few years, a longer lock-in is a real cost even if its rate is lower. A two-year lock-in and a three-year lock-in can look similar on paper. If you sell in month 30, the two-year lock-in has ended and the three-year one has not.
Jason and Mei's notes show that Offer B's lower starting rate comes with a longer lock-in, while their plans include a lump sum and possibly a move within a few years. Neither the lower rate nor the longer lock-in decides the choice alone. Both go into the comparison.
For each offer letter you have, write down:
the lock-in period the penalty percentage whether partial repayments are allowed during the lock-in and after it, with the minimum amount, the notice period and any yearly cap what happens if you sell during the lock-in, including any sale waiver clause what a partial repayment does: lower the instalment or shorten the term, and whether you get a choice
Then pick a point in time that matches a plan you might really have, get the outstanding balance at that month, and work out the penalty as the penalty percentage x the amount repaid. Use the full outstanding balance for a full repayment or for a sale not covered by a sale waiver clause, or the partial amount for a partial repayment. For the activity, a convenient point to test is the middle of the lock-in, where most loans would still charge the full penalty. You'll need the outstanding balance at that month.
Take one loan offer and work out the penalty if you repaid the whole loan halfway through the lock-in period.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).