Many would have heard of interest offset loan in Singapore when it comes to mortgages, currently offered by three banks. However, most either do not quite understand how it works, or could yet fully appreciate the true benefits of having such a feature in their home loan. With interest rate expected to continue to head north though at a slower pace, de-leveraging becomes a key theme going forward and it is timely now to review how interest offset works and why one should consider it.
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An interest offset mortgage loan is one where the bank provides concurrently a current account that pays the borrower back the same deposit interest rate as the mortgage rate charged, for up to a certain percentage of the amounts deposited with a cap set based on the outstanding mortgage loan at any point in time. The interest earned on the qualifying deposit amounts every month is then used to “offset” against the interest charged on the mortgage loan hence resulting in the borrower reducing his loan more repaidly than otherwise.
We like to introduce HSBC’s SmartMortgage, with one of the highest qualifying deposits ratio of 70%, amongst the three banks with interest offset accounts in Singapore (StanChart at 67% and Citibank at 50%).
Let’s take it look at how it works by way of an example. Assuming Mr. Tan just refinanced an outstanding loan of $700,000 to HSBC on a 25-year tenure that comes with the SmartMortgage current accout and below is a summary of the offseting effect should Mr. Tan deposit $200,000, $700,000 (equivalent amount to his loan) or even $1,000,000 into his SmartMortgage current account.
Notice how the interest earned on the qualifying deposits is now used to “offset’ against the interest component in the monthly repayment so that more of it goes towards reducing the principal loan. Mr. Tan still pays the same mortgage repayment every month of $2,967. In scenario A where there is no interest offset current account, he would be paying approximately 40% of that as interest to the bank. In scenario B when he deposits $200,000 of his idle funds into his SmartMortgage account, he reduces this interest costs by 20% from $1,167 to $933 which has the same effect of reducing his mortgage interest rate by 20% from 2% to 1.6%. What happens if Mr. Tan deposits the equivalent amount to his loan of $700,000 idle funds into SmartMortgage? That would be scenario C where his interest component is further reduced to $349 which effectively means he is paying only 0.60% on his home loan. In the last scenario D when Mr. Tan deposits $1m idle funds into SmartMortgage, his mortgage interest offset remains the same as the bank has capped the maximum offset at 70% of the outstanding loan, ie. $490,000.
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Now one wonders why would someone with idle funds of $700,000 still need to take up a home loan of $700,000 with the bank? That depends on one’s objective. We will look at four key benefits of an interest offset loan with HSBC’s SmartMortgage?
1. Added Assurance When Choosing Floating Rate Over Fixed Rate Home Loan
As the gap between the lowest floating rate (currently at 2%) and the lowest fixed rate (currently at 2.48% for private properties) widens significantly in recent months, more homeowners are caught between a rock and a hard place. On one hand, there is reluctance to sign for fixed rate at such high levels unseen in Singapore for the past decade lest one ends up with a lemon should global recession hits and rates come tumbling down; on the other hand, there is fear of runaway interest rates if left unhedged with a fixed rate home loan.
An interest offset loan becomes a very useful mitigating weapon at one’s disposal in such a situation. When choosing a floating rate over fixed, one does not have to lose control totally even with rising interest rates as interest costs can be lowered by parking idle funds into the SmartMorgtgage account as we have seen in scenario B above (placing $200,000 deposit reduces the interest cost to $933 in the 1stinstalment which is exactly how much interest will be charged when the same loan of $700,000 is signed at 1.60%, instead of 2%)
2. Reducing Interest Costs Without Doing Actual Prepayment
Most of us will not have so much idle funds to do a scenario C where one could effectively pay down the loan in full. But many would have some kind of rainy-day funds in cash. With rising mortgage rates, more people will want to de-leverage but it may not always be feasible to do partial prepayment as there is penalty during the lock-in period.
An interest offset loan has the same effect as prepayment when idle funds are deposited anytime to offset against monthy interest costs, without attracting a prepayment penalty.
3. Access To Liquidity With Minimal Cost
Now even if one has all the funds to fully redeem and discharge a loan, depleting all liquidity on hand requires careful deliberation. What if one suddenly needs access to a cheap source of funds for emergencies or some unexpected situations like a change in one’s income position which makes it now difficult to apply back for term loan. Don’t forget it’s harder to get the same quantum on a term loan as it entails more risk for the bank which grants a much-reduced loan amount after deducting CPF usage on the property.
Compare that with parking one’s idle funds in an interest offset account – there is no need for such prolonged deliberation as withdrawing funds for use in emergencies is as easy as putting money in with no restrictions whatsoever like a savings account! For high networth individuals or seasoned investors, this access to liquidity is highly valued when a day’s delay could make or break a deal or cause one to pass up on an opportunity to snatch a steal (stock market corrections, distressed property sale, etc).
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In fact, there is another good reason why one may not want to pay down fully on a mortgage – for estate planning where one could take up a mortgage insurance through having a home loan, thereby creating another set of inheritance in event of claims while still holding on to one’s cash. We will discuss that in a later article.
To balance things up, this access to liquidity does come with some minimal costs. In scenario C above, by choosing not to fully paydown and discharge the loan, Mr. Tan is effectively “pre-paying” $490,000 and still service an interest of 2% p.a. on $210,000 (or put in another way – 0.60% p.a. on $700,000). He also gave up the deposit interest he would have earned on $210,000 had he actually use $490,000 of his funds to prepay the loan and puts the remaining into a fixed deposit account. Still, this combined cost of likely not more than 1% p.a. could be easily beaten with good timing on entry and exit points for investments.
4. No Loading On Interest Rate With SmartMortgage
The best part about HSBC’s SmartMortgage is that it does not load additional spread or interest on the floating rate home loan packages that the bank is offering at the moment. This makes it an excellent choice for those who like to bet on floating rates staying low or going up very gradually, yet retain a level of control on how much interest costs to service very month through an interest offset account.
And HSBC is offering very competitive spreads on SIBOR-based home loans starting from +0.25% right now, along with some other very compelling benefits which our consultants would love to share with you. And don’t forget when you take your home loan through us here at MortgageWise, we also offer you real savings in transaction costs for both purchase (special legal fee of $1,800 net including mortgage stamp duty & gst) and refinancing home loans ($150 valuation fee offset). Both subject to a minimum loan of $500,000.
So, speak to us today for the best home loan rates!
Since 2014, MortgageWise.sg has provided thought leadership in the mortgage planning space in Singapore, taking deep dives into the latest developments in the industry, providing useful mortgage tips, and making sense of rate movements. We seek to build trust with clients over the longer term instead of doing product-peddling for quick one-time deals. That’s why we always present “whole-of-market” perspective including home loan packages that some banks do not pay us.