what to consider when refinancing home loan

What Is A Combo Loan?

Unknown to many, one can actually combine the benefits of a fixed rate home loan with that of a floating rate home loan in what is simply known as a combo loan in the industry.  DBS calls it “managed mortgage”.  Not all banks offer this option though, but there are a handful that does – the likes of DBS, UOB and HSBC.

With the latest 3-month SIBOR hitting 1.50709% (as at 2 Apr), fixed rates have been rising in the last few months.  The current lowest 2-year fixed rate for private properties starts from 1.70% in the first year, and that for 3-year fixed rate from 1.80%.  Compare this with the lowest FDR (fixed deposit rate) home loan floating rate starting at 1.65% (for completed properties).

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The gap between fixed and floating is still small at around 0.1%-0.2%.  Does this justify going for fixed rate? It depends. If the size of the loan is substantial like above $1m, it is still quite a considerable amount of savings especially if interest is going up at a snail pace for FDR home loans.  Read our recent article on how the banks in Singapore adjusted FDR pegs up across-the-board, but only after almost two years of SIBOR running up.

So how exactly does a combo loan work?  As the name suggests, it is breaking the housing loan into two parts – one part that is tied to a fixed rate loan, another part that is tied to a floating rate package.  For example, if one’s home loan is $800,000, one can opt to split it equally into two parts with $400,000 on fixed rate and another $400,000 on floating rate. Alternatively if one has plans to pay off a portion of the loan quickly within a year, say $200,000, and prefers a longer fixed rate for the rest of the loan, then one could opt for a combo loan with $200,000 on a floating rate with no lock-in period with the remaining $600,000 on a 3-year fixed rate package.

The homeowner would still sign one single contract (ie. Letter of Offer) with the bank, but it will clearly state the two different packages (and the respective terms) and how much of the loan is allocated to each. However, by and large most of the commercial terms would be the same in so far as it governs the contractual obligations between the lender and the borrower.  Typically only those terms that pertained to the respective package details will be different, like the interest rates for the first, second, third and subsequent years, and the commitment (or lock-in) period that governs how much of the loan the borrower can prepay without penalty.

As taking a combo loan means signing up to fixed and floating rate home loans from the same bank, very often one cannot get the absolute lowest rate in the market for both parts of the loan.  It will be perfectly fine to just get the lowest rate for one part be it fixed or floating, but since floating rate very often implies an intention to pay down, I would aruge that focusing on the lowest fixed rate would make a better starting point when shopping for combo loans.  In reality it is not so straight-forward as not all banks that offer fixed rate packages also offer floating rate on FDR pegs with no lock-in.  More often than not, those adjustable-rate packages with no lock tends to be pegged to SIBOR.

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Since sourcing for a good combo loan requires some effort, what would be some situations where a combo loan is more useful compared to the typical all fixed or all floating loan?  Three such situations come to mind (remember we are talking about those with bigger loans for example above $1m):

 

1. When One Is Not Sure On The Direction Of Interest Rate Movement

For a loan of $1m, even a 0.20% savings amount to $2,000 per year (on a straight-line basis which will be slightly overstated).  Some might remember the most recent episode in 2016 when there was a scramble to sign on 3-year fixed rates at 2% only to have SIBOR retreated and fixed rates tumbled back to 1.60-1.80% and stay down for the next two years!  When it comes to interest rate forecast I can vouch that it is indeed a tricky business and one cannot just listen to analyst’s call at the start of the year.

 

2. When One Has High Balances In CPF Ordinary Account To Pay Down When Need Arises

There are those with high balances sitting in CPF account earning the statutory minimum risk-free return of 2.5% compounding interest.  As long as one can service the monthly repayment comfortably, from a financial standpoint per se and ignoring the need to access CPF funds before 55, it does not make sense to take a lower mortgage by deploying more CPF towards the purchase of property.  Especially when this gap between floating rate to 2.5% is almost 1% which means someone with a $500,000 CPF balance is losing out on earning $5,000 p.a. in compound interest if he uses it as part of equity payment for the property.  That is also one way to build up one’s nest egg for retirement.

So as long as the prevailing interest rate is much lower than CPF’s 2.5%, one should at least match the floating rate portion of the combo loan with the amount in one’s CPF Ordinary Account.  This means that when interest rate starts creeping up and levels up with 2.5% eventually (we do not know how long this will take –  is it a straight line up or see-sawing), one could simply redeem the floating rate portion of the loan as long as there is no lock-in penalty.

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3. When There Is Plan To Sell The Property Soon

Fixed rates almost certainly comes with a lock-in period that corresponds to the fixed term (2-year or 3-year) during which there will be a 1.5% penalty on any amount of loan redeemed. On a loan of $800,000, if one ends up selling the property for some reason after just one year, this works out to a penalty of $12,000 that the bank earns instead of the seller (from the cash proceeds of the sale).  Splitting the loan into two parts with one part floating attracting no such penalty will lessen this cost for the seller; yet it gives an assurance that should he take much longer time to sell the property and interest keeps rising, his interest costs will be contained with part of the loan on fixed rate mortgage.  This is like a middle-of-the-road option for those who are definitive about selling.

Of course nowadays some banks do offer fixed rate mortgage that comes with waiver of such lock-in penalty when redemption is due to a sale of the property.  Still very few banks offer this feature which may also be taken away as there is a cost to the bank whenever a fixed rate contract is terminated.

We have highlighted three scenarios where a combo loan may be a worthwhile consideration. Speak to our consultants today if you like to explore such an option which offers the best of both worlds.

We hope this article has helped shed some light on this often obscure topic in the mortgage industry where many are not aware of such a loan structure.

 

Since 2014, MortgageWise.sghas provided thought leadership in the mortgage planning space in Singapore, taking deep dives into the latest trends in the industry, providing useful mortgage tips, and making sense of rate movements. We aim to build trust with clients for longer term partnership and not just do product-pushing for a one-time deal unlike bankers. That’s why we always present “whole-of-market” perspective including packages that banks do not pay us. That’s why many have chosen to work with us in the end notwithstanding the sheer number of brokers and agents out there. See theirtestimonials.

 

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About Darren Goh

Darren Goh is the Executive Director of MortgageWise.sg, a thought leader in the Singapore mortgage industry, with frequent interviews and quotes by the press - Business Times, Straits Times, Zaobao and EdgeProperty for his views on the latest mortgage trends. He is an avid property investor with careers in banking & real estate before becoming an entrepreneur.
View all posts by Darren Goh

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