How Home Loans Work

Are you considering buying a property but unsure how home loans work? Don’t worry, we’ve got you covered. In this article, we’ll explain the different types of home loans, how interest is calculated, and what you need to know about repayments and refinancing. Let’s dive in!

What is a Home Loan?

A home loan, also known as an HDB loan or a bank loan, is money borrowed to help you purchase a property. If you’re buying an HDB flat, you may be eligible for a concessionary interest rate loan from HDB. For other types of properties, you can choose to obtain a home loan from a bank. Here’s what you need to know about home loans:

  • Your property serves as collateral for the loan.
  • The loan amount is based on your eligibility.
  • The loan is disbursed after the downpayment is made.
  • Interest is charged from the first disbursement.

Who is Eligible for a Home Loan?

Eligibility for a home loan depends on various factors. HDB and banks have their own criteria for prospective borrowers, including minimum monthly income, age, loan quantum, residency status, and compliance with credit requirements. If you’re self-employed or have irregular income, you’ll need to demonstrate your ability to repay the loan based on the lender’s criteria.

Types of Home Loans

When it comes to home loans, there are different options available. HDB offers a concessionary loan with an interest rate pegged slightly above the CPF Ordinary Account interest rate. Banks, on the other hand, provide two main types of home loans: fixed-rate and floating or variable rate loans. Let’s compare them:

  • Fixed-rate home loan:

    • Offers a fixed interest rate for the first few years.
    • Rate remains the same even if market rates fall.
    • After the fixed rate period, interest becomes variable.
  • Floating or variable rate home loan:

    • Interest rate varies based on a reference rate.
    • Reference rate can be CPF Ordinary Account, SIBOR, SOR, or a rate determined by the bank.
    • Interest payable increases or decreases depending on the reference rate.

It’s important to understand the differences between these loan types. Ask your bank to explain how the reference rate is derived, how often the interest rate may be reset, and under what circumstances the rate is changed.

How Interest is Computed

Interest on your home loan is usually calculated using the monthly reducing (monthly rest) method. Even a slight increase in interest rates can impact your monthly installment and the total amount of interest paid over the loan tenure. Here’s an example that illustrates the effect of different interest rates on a monthly installment for a 30-year loan:

Interest Rate Effective Interest Rate (EIR) Monthly Installment
1.24% 1.5% $2,760
1.42% 2.5% $3,160
1.61% 3.5% $3,592

As you can see, even a small increase in the interest rate can significantly impact your monthly repayment. Make sure you understand the potential effects before committing to a loan. You can also use a mortgage calculator to get a better idea of your monthly payments.

What You Can Do: Pre-pay Your Home Loan

If you want to reduce your monthly payments and save on interest in the long run, you can consider making a lump sum pre-payment on your home loan. However, be aware that there may be penalties for pre-payment, so check with your lender first. Here’s an example of the potential savings from a partial pre-payment:

Prepayment Amount (% of outstanding home loan) Monthly Home Loan Payment Total Interest Saved over Remaining Loan Tenure
$40,000 (5%) $4,440 $30,150
$80,000 (10%) $4,210 $60,300

Assuming the home loan interest rate rises to 5% per annum and remains at that level for the remaining loan tenure of 25 years. The actual savings may vary, so it’s essential to check the terms and conditions of your home loan with your lender.

All About Your Loan

Before finalizing your home loan, there are a couple of important documents you should be familiar with: the HDB Home Loan Eligibility Letter (HLE) and the property loan fact sheet.

HDB Loan Eligibility Letter

To determine your eligibility and the maximum amount you can borrow, you’ll need to apply for an HDB Loan Eligibility (HLE) letter. The HLE letter provides information on your borrowing capacity, monthly repayments, cash requirements, and other terms and conditions. It helps you plan for your home purchase effectively.

Property Loan Fact Sheet

If you’re getting a home loan from a bank, the bank must provide you with a property loan fact sheet. This document outlines how potential interest rate changes will affect your monthly installments. It also includes key features of the loan, such as the loan amount, tenure, total repayment amount, lock-in period, interest rate, and repayment schedule.

Before committing to a home loan, make sure you go through these documents and understand the terms and conditions. If you have any questions, don’t hesitate to ask your lender for clarification.

Refinancing and Repricing

Refinancing allows you to switch from your existing home loan to a new lender with lower interest rates. If you choose to refinance with your current bank, it’s called repricing or conversion. Reviewing your home loan regularly is important, especially when your lock-in period is over, as you may find better options for saving money. However, HDB flat buyers are not allowed to refinance their existing bank loan with an HDB loan.

Before You Refinance

Before you make the decision to refinance your home loan, consider the following options:

  • Sticking to your current housing loan package.
  • Converting to a different housing loan package with your existing bank.
  • Taking up a refinanced housing loan package with a different bank.

To compare your options effectively, follow these steps:

1. Check with your current bank

Speak with your existing bank and ask about repricing options before exploring other banks. Inquire about any fees or penalties that may apply during the lock-in period. Here are some questions to ask your bank:

  • Will I incur any fees for terminating my current housing loan package?
  • Can I convert the loan to a more attractively priced one? What charges are involved?
  • Is there a lock-in period for the new housing loan package? If so, how long is it, and what charges are involved?
  • Can you show me how I will benefit from the refinanced package?

2. Compare loan packages

Compare the repriced loan from your current bank with other refinancing packages to determine if switching lenders is the right option. Consider the updated repayment schedules and the advertised rates and effective interest rates (EIR) for each package. Keep in mind that changing your loan package may result in different installment amounts and interest rates.

3. Read the fine print

Before committing to a refinanced housing loan package, read the terms and conditions carefully. Make sure you understand what the new package offers and check the CPF Housing Withdrawal Limit that applies to you when refinancing your housing loan.

What If You Can’t Pay?

In case you encounter difficulties with your monthly payments, it’s important to approach your mortgagee promptly, whether it’s HDB or a bank. HDB may provide alternative options and advice, while the bank can help you restructure your loan. Remember that your home loan is secured against your property. If you fail to make payments, HDB or the bank has the authority to sell your home to recover what you owe.

Find Out More

If you want to learn more about housing loans and make informed decisions, download our guide: “About Housing Loans: Key Questions to Ask Your Bank Before Taking a Housing Loan.” It’s packed with valuable information to help you navigate the loan process.

Remember, understanding how home loans work is essential before embarking on your property purchase journey. If you’re ready to take the next step, visit ATICE.INFO for more resources and expert guidance. Happy home hunting!