My long term plan for my home loan is to get it paid, and not have to live off baked beans under a cardboard box. Is that a lot to ask for? Apparently yes. No one’s allowed this privilege, not without facing the Chamber of 10,000 Maths Illusions. Better believe it; banks hire product teams whose sole objective is to make stuff look cheaper than it really is. Including your home loan. In this article, I look at ways to bypass their tactics and plan long term:
S’poreans: Live on a real tropical island; pay for a fake tropical beach.
Long Term Planning for Home Loans
When it comes to home loans, most of us only worry about monthly repayments. It makes us feel better. If we actually need to process the fact that we borrowed $350,000 to a over a million, we might puke.
But this myopia costs home owners a lot of money in the long run. If you’re just a property investor, short term planning is no problem; you’ll be selling the house, so you won’t be dealing with the full loan tenure. But if you’re a home owner, you need a different perspective.
You need to:
- Consider The “Thereafter” Costs of the Loan
- Avoid Assumptions About Refinancing
Consider the “Thereafter Cost” of the Loan
That’s the method I was taught in Primary school and that’s the method I’ll use, dammit.
When getting a home loan, banks try to distract you with “teaser” rates. These are extremely low interest rates, which are usually offered for the first three to five years.
As a long term home owner, you need to look beyond these. You need to calculate the “thereafter” costs; the total interest paid over your entire loan tenure.
Here’s an example:
Let’s say I need a $1,000,000 loan, with a 30 year loan tenure. I have two options, Bank X and Bank Y.
When the banks calculate my interest rate, it consists of two parts: A fixed spread, plus the Interbank rate (usually SIBOR or SOR). For the purposes of this example, we will assume a 3 Months SIBOR rate of 0.35%.
The fixed spread for Bank X is 0.75% for three years, and 0.90% from the fourth year onwards.
The fixed spread for Bank Y is 0.65% for three years, and 1.25% from the fourth year onwards.
|
Bank X |
Bank Y |
Year 1 |
3 Months SIBOR + 0.75% |
3 Months SIBOR + 0.65% |
Year 2 |
3 Months SIBOR + 0.75% |
3 Months SIBOR + 0.65% |
Year 3 |
3 Months SIBOR + 0.75% |
3 Months SIBOR + 0.65% |
Year 4 and Thereafter |
3 Months SIBOR + 0.90% |
3 Months SIBOR + 1.25% |
*Assume 3 Month SIBOR = 0.35%
Notice how Bank Y looks sexier in the first three years, whereas Bank X has all the appeal of Drew Carey in Spandex.
But when we crunch the numbers, here’s what they add up to:
Bank X (Total Interest Paid Over 30 Years) = Approx. $195,031.62
Bank Y (Total Interest Paid Over 30 Years) = Approx. $240,868.80
Bank X would have saved me over $45,800.
And before you ask, no, most bankers won’t set up nice comparison tables for you. It’s not in their (drum roll for bad pun) interest. You need to visit loan comparison sites like SmartLoans.sg, and look up the tables.
“Time is money. No, I mean for me; I’m a banker. Everyone else actually has to work.”
Avoid Assumptions About Refinancing
Some bankers will hand-wave the “thereafter” costs. They’ll tell you it’s no big deal, because you can always refinance when the rate goes up.
Well, you can plan to refinance to a cheaper loan; but that’s gambling. The home loans market isn’t static. Anything from bus routes to Angela Merkel having a bad day can turn it upside down. You can’t assume the rates you see now will be there in four years.
Let’s go back to my earlier example. Let’s say someone from Bank Y tells me:
“Who cares if we’re more expensive? Take our loan for three years, then refinance.”
“Okay, I admit I exaggerated about the rates dropping. Can we not wait another 25 years?”
So I take their advice. On the fourth year, I check banks to switch my loan to.
Then I freak: Because interest rates have spiked in that time, and now I can’t find a fixed spread below 1%. If I had gone with Bank X, I would have a fixed spread of 0.90% for the rest of my loan tenure. Now the same opportunity just doesn’t exist.
And consider this: Interest rates are at a historical 10 year low. Due to the poor global economy, governments and banks have been trying to stimulate buying and lending. That happily involves keeping home loan rates low. But industry experts have stressed that, as the global economy improves, it’s highly probable that the banks’ interest rates will increase.
If you’re interested in more long term planning for home loans, follow us on Facebook. We’ll keep you up to date on the local property scene. But for now, crunch some numbers and make sure you’re not over-paying interest.
What are your long-term plans for your home loan? Comment and let us know!
Image Credits:
ashkyd, edenpictures, earls37a, watchsmart
Get more Personal Finance tips and tricks on www.MoneySmart.sg
Click to Compare Singapore Home Loans, Car Insurance and Credit Cards on our other sites.
More From MoneySmart