Getting a housing loan can be daunting. Everyone advises borrowers to compare different offers, shop around for the best rates and calculate their overall loan costs.
And if you are like most people on Planet Earth, that is where you get lost. The endless paperwork and tables outlining repayment plans do not make anything clearer.
Everything can become much cleared if you understand the basics of home loan interest rates. These rates influence and interact with all the other factors of your loan.
They affect how much money you can borrow, for how long, and at what monthly installment.
So how is housing loan interest calculated?
Keep reading this as we discuss real-life examples of amortisation tables, factors behind interest rates, and do Math that nobody dares to touch.
How Is Mortgage Interest Calculated?
Singapore used to have the so-called interest-only loans up until 2009. These loan packages entailed the first installments comprise just the interest.
That interest represents the extra money your lender is getting. Obviously, lenders wanted to avoid not getting that money in the cases of early loan repayment.
But that situation has changed now. Rates in Singapore work according to an amortisation schedule. This means every instalment includes a portion of the principal plus the interest.
The amount of each component is determined by the rate and loan tenure.
Here’s what that means:
- If you have a 30-year loan with an interest rate of 7%, your initial repayment will be more than half in the form of interest.
- If you have a repayment period of 5 years with an interest rate of 2%, you end up paying nearly one-third of your first payment towards the interest.
The interest amount decreases throughout the remainder of the loan as more principal is paid off and less money needs to be borrowed. This means that each instalment will contain progressively lower amounts of interest until the outstanding loan is repaid.
To help you understand better, let’s look at a simple amortisation table. Suppose you take a $10,000 loan over 12 months at a 7% interest rate:
Notice how the payment amount remains the same; that’s your installment. The interest is calculated at a 1.8% rate from the outstanding balance.
| Payment Number | Payment Amount | Interest Amount | Principal Reduction | Remaining Balance |
|---|---|---|---|---|
| 1 | $841.48 | $15.00 | $826.48 | $9,173.52 |
| 2 | $841.48 | $13.76 | $827.72 | $8,345.80 |
| 3 | $841.48 | $12.52 | $828.96 | $7,516.84 |
| 4 | $841.48 | $11.28 | $830.21 | $6,686.63 |
| 5 | $841.48 | $10.03 | $831.45 | $5,855.18 |
| 6 | $841.48 | $8.78 | $832.70 | $5,022.48 |
| 7 | $841.48 | $7.53 | $833.95 | $4,188.54 |
| 8 | $841.48 | $6.28 | $835.20 | $3,353.34 |
| 9 | $841.48 | $5.03 | $836.45 | $2,516.89 |
| 10 | $841.48 | $3.78 | $837.71 | $1,679.18 |
| 11 | $841.48 | $2.52 | $838.96 | $840.22 |
| 12 | $841.48 | $1.26 | $840.22 | $0.00 |
- The first interest is $15 because it represents 1.8% of $10,000.
- The second interest rate is $13.76 because it is calculated from of $9,173.052 (the remaining balance).
This progressive decrease, also known as the reducing balance method, has two advantages:
1) It allows you to repay your debt early.
2) It helps you save money in the long run because you pay less interest.
That brings us to the following point.
How Much Interest Do You Actually Pay?
Your mortgage interest rate defines the installment and the total loan cost.
Let’s say you want to purchase a $400,000 home and have a $80,000 downpayment. Let’s say your loan term is 30 years and the interest rate is 6.7% p.a.
In this case, your installment will be $2,348.22/month. Multiply that by 360 months, and you get an $845,359.2 total loan cost. Deduct the taxes and insurance cost, and your total interest reaches $423,360.23.
A 6% interest decreases the monthly repayment to $2,201.90. That brings the total interest paid down to $370,682.20.
Notice that even a small decrease in mortgage interest makes an essential difference in total loan paid.
And that is for a fixed tenure. That is just one of the factors affecting your mortgage rates. Let’s review this topic below.
Factors That Affect Mortgage Rates
Your mortgage rate can fluctuate according to market conditions, property price, loan type, and more. You can use this knowledge to obtain the best HDB loan for your needs:
Fixed Interest Rate Vs Variable Interest Loans
A fixed rate means that your mortgage rate will stay the same throughout the life of the loan even if market conditions change. A fixed-rate mortgage offers you peace of mind in case interest rates go up, as it locks in a low repayment amount throughout the loan tenure.
A variable-rate home loan, on the other hand, is subject to market fluctuations. The floating interest rate may decrease or increase depending on current economic conditions.
It also means that you can benefit from a decrease in the mortgage interest rate, lowering your monthly repayments.
How is housing loan interest calculated for variable rates?
Your interest rates could be tied to a reference rate such as:
- CPF Ordinary Account
- Singapore Interbank Offered Rate (SIBOR)
- Singapore Swap Offered Rate (SOR)
- Your bank’s internal rate
For example, HDB buyers can get concessionary loans for HDB flats at a rate pegged at 0.1% above the CPF Ordinary Account benchmark rate.
Therefore, buying a house with floating rate is riskier for HDB and private loans. The longer you take to pay, the riskier it becomes for the rate to rise over time.
Property Price And Loan Amount
The higher the property price or loan amount, the lower the housing loan interest rate. If that applies to your loan, the bank will be content with its “healthy net margins.”
This term means they are getting enough net profit without burdening you with a steeper interest.
Credit Score
Your credit score is another essential factor you need to consider. A low credit score will increase the risk for financial institutions, and they’ll charge you a higher interest rate.
That is why it is important to keep your credit score healthy so you can enjoy lower mortgage rates.
If you are unsure of your current credit rating, check with Singapore’s Credit Bureau before applying for a home loan.
Getting your application rejected because your requested sum is too large will lower your rating further.
Loan Tenure
There is a difference in interest rates based on loan term:
- The longer the loan tenure, the higher the interest rate.
- A shorter term implies a lower rate.
That is because it increases the risk for lenders as more money is borrowed and needs to be repaid over a longer period.
On top of that, having a shorter duration reduces the total amount of money you will be repaying in interest.
Total Debt Servicing Ratio And Mortgage Servicing Ratio
These two variables limit the amount of debt you can take proportionally to your income.
- The Total Debt Servicing Ratio (TDSR) is capped at 55%, meaning you cannot pay more than 55% of your gross income for loan installments.
- The Mortgage Servicing Ratio (MSR) is capped at 30%. Therefore, you cannot give more than 30% of your gross income towards mortgage loans.
If you already have various active loans, that will lead to higher paying interest.
Can You Lower Your Monthly Mortgage Payment?
Your interest rate may be high, but can you get away with lower monthly payments? We will review several factors below:
- Choose a longer loan: This strategy decreases your monthly instalments, but increases your overall loan costs.
- Buy a more affordable home: Buying a home with a lower purchase price can reduce the tenure and the size of your mortgage.
- Shop for lower rates: Any homebuyer – including you – should compare the rates offered by different banks and apply for a new loan accordingly.
- Increase your credit score: A good credit score can get you discounted rates, so try to improve it. Pay your bills on time, avoid making too many hard inquiries, and keep your credit utilization ratio low.
- Refinance your home loan: You can refinance your loan by switching to another lender that offers lower interest rates. That interest payment will affect your monthly installment considerably.
- Get a larger downpayment: You can do this by taking a bridging loan, borrowing from friends and family, or borrowing more money from your CPF account. This will reduce your loan balance and the lender’s risk, resulting in lower interest rates.
Lending Bee can help.
At Lending Bee, we understand the importance of getting the best deal for your home loan. We provide tailored solutions that work with your financial goals and plans.
Get your bridging loan here or get in touch to help you figure the best strategy.
About Ashley Sim
Calling herself a “professional multi-tasker”, Ashley worked as a relationship manager in a bank for five years. She left her job just before the pandemic happened and became a freelance writer for about a year. Now, she’s making the most of her love for writing and knowledge of the banking and financial industry in her role as a content marketing lead. She hopes to help people make better financial decisions through her content and campaigns.
