As the low interest rate environment of 2020 persists, we've seen banks offering some of the lowest fixed and floating rates for home loans in the past few years. Even with this ongoing pandemic and the looming threat of global recession, getting to pay less on our mortgage can be considered a small silver lining for us as homeowners. However, banks ultimately have to find ways to still earn money from us, such as increasing the interest rate floor.
What is an interest rate floor?
The interest rate floor states what is the lowest your interest rates can go. This is one of the agreements between you and the bank that can be found in your Letter of Offer. Your Letter of Offer may have something that reads something like this:
In the event the 1-month SIBOR falls below 0.10%, the 1-month SIBOR shall be fixed at 0.10%.
How does this work? For example, let's assume your home loan package is currently 1M SIBOR + 0.25%. In this example, your interest rate floor is 0.35%. That means you'll never pay less than 0.35% for your home loan.
Another type of interest rate floor applies to the entire home loan package, not just the current SIBOR. You may see a clause that looks like this:
Minimum Effective Interest Rate of 0.85% p.a. applies
This means that your ENTIRE home loan package cannot go below 0.85%, no matter how low SIBOR gets.
When you think about it, HDB loans also have a rate floor. The HDB loan is always set at 0.10% above the CPF Ordinary Account interest rate, and the CPF Ordinary Account cannot be lower than 2.50% by law. Therefore, HDB loans have a interest rate floor of 2.60%.
Why do banks introduce interest rate floors?
To avoid the extremely rare situation when interest rates become negative. This has never happened in Singapore before (and probably would not, because of our unique monetary policy). However, terms and conditions are there to cater to every possibility, no matter how rare. That is why most banks keep their interest rate floors close to zero.
If interest rates do drop below zero, and there is no interest rate floor, then a bank may end up having to pay you for taking the home loan! While this is great, I'm sure you'll agree with me that no bank will want to allow such a situation to occur.
Why do interest rate floors apply to SIBOR packages?
SIBOR-linked home loan packages will be affected because SIBOR is something that the bank cannot control individually. That is why we insist that SIBOR floating rates are the most transparent and fair home loan packages. Banks cannot stop SIBOR from falling in the low interest rate environment that we are currently in.
Are banks allowed to raise the interest rate floor in the middle of my home loan?
The simple answer is yes, but it is extremely rare.
All banks in Singapore reserve the right to adjust the terms and conditions of their home loan at any time, as long as they give one month's notice. Unfortunately in April this year, one bank decided to use that power to raise the interest rate floor from 0.10% to 0.90%. Although the bank eventually postponed the announced revision from May 18th to January 1st, 2021, customers were already upset.
In the 5 weeks since, 1M SIBOR has dropped from 0.75% to 0.25%! Last year, this same bank was offering home loan packages such as 1M SIBOR + 0.25%. That means, now that the interest rate floor increase has been postponed, the bank's customers are paying an interest rate of only 0.5%! You would think you were getting the deal of a lifetime if you had a equally low spread SIBOR package in this low interest rate environment.
Should 1M SIBOR continue to remain low, once the interest rate floor is raised to 0.90% in 2021, you would end up paying 1.15% instead. That's DOUBLE what you would've been paying if not for the revision.
The bank is now offering a waiver of all applicable penalty and administrative fees should affected customers wish to refinance. However, since their home loan bank spreads are still so low, from a financial point of view, it would not make sense to refinance. At this point in time, we doubt there will be another bank offering a home loan package that's lower than 1.15%.
However, that is only one factor to consider when deciding to refinance, of course.
Will other banks follow suit and increase their interest rate floor?
At this point in time, we don't think so. The backlash from the April announcement was so swift that no other bank will want to risk negative PR, especially as the COVID-19 pandemic continues to affect livelihoods.
Instead, as SIBOR appears to have stablised, banks are now offering higher spreads. We also expect banks to start offering attractive fixed rate packages to appeal to customers to move away from SIBOR packages.
Not sure which bank to go with now?
It is the job of a mortgage broker to advise you about your options when it comes to home loans in Singapore. At Mortgage Master, based on our years of experience in the industry, we know best which home loan packages are suitable for your financial situation, and whether they can save you money in the long run.