(Last Updated: 6 Jun, 2021)
As SIBOR has crashed effectively in 2020, we’ve been getting more questions on whether to choose 1-month SIBOR and 3-month SIBOR. So, I thought it may be good we give our take in this blog.
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As our views and recommendations are always backed by data, we will take a look at the paths of the 2 indices over the last 20 years. This is especially important if you believe history tends to repeat itself.
First, for the benefit of those new to mortgages in Singapore, SIBOR stands for Singapore interbank offer rate – the rates that 20 Contributor banks who participate in the interbank market lend or borrow from one another where bids and offers are submitted to ABS (Association of Banks in Singapore), the administrator for SIBOR, and published every business day morning at 11.30am. Incidentally, in a bid to make SIBOR more reflective of true market activities, there is ongoing transitional testing (July to Dec 2019) for a new version of enhanced SIBOR on a new waterfall methodology which will come into effect by next year and by which time 12-month SIBOR will be discontinued.
What we do need to understand as end-borrower, is how our mortgage interest rate is set if your loan is pegged to 1-month or 3-month SIBOR respectively. We will start with 1-month SIBOR. If your home loan rate review (or rate-setting) date is on the 5th of every month, the bank will look at what is the value of 1-month SIBOR published on this date and your mortgage rate will then be set accordingly as per your contract. For example, if you have contracted with the bank for a spread of 0.30% above 1-month SIBOR, your interest rate will be 1.88% (1-month SIBOR now) + 0.30% = 2.18% for the next month and the bank will send you an advice on the exact repayment amount for next month based on 2.18%. This exercise is repeated every month and in periods where there is little volatility or movements in SIBOR, you can expect to be paying more or less the same amount every month.
The same happens if you are contracted on 3-month SIBOR. The difference is your interest rate and hene the monthly instalment amount is set only once every quarter instead of every month. For example, if your rate review date falls on the 15th of Oct, the next rate review date will be on 15th of Jan, followed by 15th of Apr and so on. Your interest rate will be set or “fixed” for a 3-month period each time.
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Fixed Rate Effect Of 3-month SIBOR
For this simple reason of having a “fixed rate” effect over 3-month, we hold the view that in periods where interest rates are rising it would theoretically be better to be on 3-month SIBOR than 1-month, and the converse will be true when interest rates come down. Having said that, the difference might not be that significant if the increment is gradual over time as both will eventually move in the same direction. We always like to give the analogy of paying additional $1 every month or paying $3 more every 3-month. Homeowners will still benefit slightly on fixing the rate every 3-month when interest is moving up, but that’s provided the increase is linear which may not always be the case. As you can see from the historical chart, there are many periods where SIBOR simply trade sideways for long periods as it moves in steps on its way up or down.
Gap Between 1-month SIBOR and 3-month SIBOR
Another observation is the gap between 1-month and 3-month SIBOR which hovers at around 0.12-0.13% in recent years since 2018 but has now converged. We also noticed this gap seems to widen when rates are falling but narrows during periods of upswing in rates. So, if this pattern holds true and rates tumble over the next two years, then we can expect to see the same wideing of gap like back in 2009-2011 or 2015-2016. Or it could turn out to be just a blip like what happened towards the end of 2017. All that depends to a large extend on the outcome of the protracted trade talks between US and China this year and beyond.
Traditionally we know that banks tend to levy a higher spread on 1-month SIBOR than 3-month SIBOR due to this gap. Hence at this moment when the two indices converged, home loan packages pegged to 3-month SIBOR packages would present lower headline rates than those pegged to 1-month. This may change when the gap opens up again or widens. To be honest, we do not presumed to know the forces behind how interbank market work but we noted this is not the first time that the two SIBOR indices have converged in the past. And each time, after a brief period of inflection when the market finally figured out the new direction be it up, down or sideways, the gap opens up again.
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While 3-month SIBOR offers more stability in terms of having to pay and manage a fixed amount of monthly repayment which resets only every 3 month, we are of the view that the elasticity of 1-month SIBOR to any changes to rates makes it a more preferred index during periods of interest rate downturn. On the contrary, when interest rate heads north, the better option is not floating rate on 3-month SIBOR but rather a fixed rate home loan. Add to that the notion of a seemingly widening gap between 1-month and 3-month SIBOR when rates fall, our gutfeel (we cannot be 100% sure on this) is that homeowners would be better off on 1-month SIBOR rather than 3-month SIBOR over the long term.
Banks like to push 3-month SIBOR to borrowers instead of 1-month. In fact, we have heard of some banks phasing out 1-month SIBOR altogether which may suggest it is less profitable than pegging their mortgage books to 3-month SIBOR? If indeed it is less profitable for lenders, surely it must mean homeowners would have more to gain on 1-month SIBOR somehow? Food for thought.
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