Tuesday, April 11, 2006

Cracking the home loan code

How banks' prevailing board rates and discounts affect what you pay
SUDDENLY, everyone is outraged by higher home loan rates.
By Larry Haverkamp
mail@AskDrMoney.com
SUDDENLY, everyone is outraged by higher home loan rates.
And it's not just the rates.
 
It is also the strange way they are calculated.
Nearly everyone with a bank mortgage is affected.
Even if you have a fixed-rate loan, you are at risk since most of these become floating (variable) after two years.
 
Recently, borrowers have switched to variable rate loans, thinking that rates may top off soon.
One bank told me most of its new loans are variable.
 
A year ago, most had been fixed.
 
I think this a good strategy. It avoids getting locked into a high fixed-rate loan for the next two years.
And variable loans cost about 0.5 per cent less than fixed rate loans.
Almost as worrying as the high rates is the complex way they are calculated.
 
Here are three examples:
  • 1. Last week, I wrote about how Mrs Money and I were shocked when we got a letter from our bank telling us our variable rate loan would increase from 2.2 to 3.85 per cent.
    We thought, 'How can?'.
    We are into the second year of our refinanced home loan and the advertised rate is 3.5 per cent.
    We learned the bank can charge us more than 3.5 per cent because of something called the 'prevailing board rate'.
    I will explain shortly.

  • 2. On 31 Mar, Gan Siok Bin's letter in The Straits Times was about their family's variable home loan.
    It was in its second year and the bank had hiked the interest rate to 4.05 per cent.
    It was also higher than the bank's 3.5 per cent advertised rate.

  • 3. On 5 Apr, Madam Gan Li Lian wrote to The Straits Times and said the same thing happened to her.
    In the last eight months, she has had five 'board rate' increases and these boosted her home loan by 1.25 per cent.
    Madam Gan thought this was wrong since she had signed a contract with the bank that guaranteed a fixed discount from the 'prevailing board rate'.
    It is happening to thousands of bank borrowers, many of whom have two-year fixed-rate loans that will expire soon.
    You could be next.
  •  
    BOARD RATE
    A central point of confusion is the little-understood 'prevailing board rate'.
    The board rate is set by individual banks.
    This system of calculating home loan rates is not mandatory and our home loans would be more transparent without it.
  •  
    With no board rate, a bank officer might say, 'Your variable interest rate is 3.5 per cent and can change at any time.'
  •  
    As it is now, a loan officer may tell you: 'The prevailing board rate is, say, 8.5 per cent from which you will receive a fixed discount of 5 per cent resulting in your paying an annual home loan rate of 3.5 per cent.'
  •  
    The discount - especially a big one - sounds good but it has little value.
    Why? Because the bank can offset it, simply by increasing the 'prevailing board rate'.
    For example, suppose the bank decides to charge you 5 per cent interest and your discount is zero per cent.
  •  
    Then it will set the prevailing board rate at 5 per cent.
    To take an exaggerated example, if the bank gives you a huge discount, like 15 per cent, it's no problem.
  •  
    The bank can simply hike the prevailing board rate to 20 per cent.
    You would still pay 20 - 15 = 5 per cent interest.
  •  
    Banks set their own board rates and every bank has multiple board rates.
    Each corresponds to the discount it has given a batch of customers.
    A higher discount simply means the bank may offset it by charging that batch a higher board rate.
     
  • WHY SO COMPLICATED?
    This brings us to the next question: 'Why like that?'
    For example, Mrs Money and I received a bank letter announcing our new home loan rate. Incredibly, it never mentioned the new rate.
  •  
    The letter said, 'Please be advised that the Bank will be revising the Board Rate Reference Home rate on your loan account from 6.4 per cent to 7.35 per cent with effect from 30 March 2006.'
    After three phone calls, I learned that the 7.35 per cent Board Rate Reference Home rate means that after discounts, the bank will charge us 3.85 per cent.
    Why go through this torture?
  •  
    One loan officer told me over the phone: 'Singaporeans like a discount so we give them one. Well, it looks like one.'

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    // posted by Shajahan @ 11:04 AM


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