Home owners looking for a mortgage in our small city of Singapore will be pampered by choices. There are at least 12 banks offering at least a total of 100 types of mortgages. Almost every package is different and it’s impossible to find a common denominator to do a comparison.

**Type of mortgages**

There are a few broad categories of mortgages here in Singapore. The most common ones are:

Floating or Variable Packages – The interest rate for this category is pegged to the individual bank’s board rate. The rates can be very attractive but because it’s pegged to the bank’s board rate, you may be subjected to fluctuations.

Market Pegged Packages – In this category, you will find the packages that are pegged to 1M SIBOR/ SOR, 3M SIBOR/ SOR, 12M SIBOR/ SOR and also their hybrid, Combined Average 3M SOR + SIBOR. While this category is very popular now, this was not the case before 2007. In fact, new packages started to mushroom in this category in 2007 in response to the many complaints on rate hikes from floating packages.

Fixed Rate Packages – The interest rate for this category are usually fixed for 1st year fixed, 2 years fixed, 3 years fixed and up to 5 years fixed. The difficulty is not about comparing the interest rate for the fixed periods but what comes after that. Lets us use the 2 years fixed package as an example

Package A Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 3M SIBOR + 0.7% | Package B Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 3M SOR + 0.8% | Package C Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 2.3% Floating |

Assuming 3M SIBOR 0.8% and 3M SOR 0.6% |

For simplicity, I have assumed the same fixed rates for the first 2 years. At first glance, we would rank Package B as the cheapest of the 3 since its 3rd year rate is the lowest. But some of you will argue that SOR as a benchmark is more volatile that SIBOR, so the cheapest package should be Package A. What about package C, suppose the floating rate stays constant at 2.3% and both SOR and SIBOR rise above 1.6% (note 3M SIBOR was more than 3% in 2006), does that mean Package C is the cheapest?

The calculation will get more complicated and difficult to compare for floating and market pegged packages. In the guide published by Moneysense, it has suggested that we use EIR or the IRR (internal rate of returns) to get a fair comparison. We think this is a good idea only if rates are consistent. For example, the 3M SOR rate is less than 0.4% now, the IRR will not be representative because we know that this rate is uncommon and its very impossible that 3M SOR will stay this low for the next 20 years. As such, if we use the IRR to compare a 3M SOR package to a 3M SIBOR or even a floating package, the IRR will not be indicative.

**MoneyIQ approach**

Our approach to loan comparison is built on Mr Larry Haverkamp’s article in The New Paper in Jun 2005. In his article, he has suggested that we compared loans based on the lock in period and penalty of the loans and that the fundamental assumption is that its always cheaper to refinance your loan after the initial 2-3 years. This is in our view a more practical yardstick in comparing loan.

Back to the earlier example,

Package A Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 3M SIBOR + 0.7%2 years lock in Legal subsidy 0.4%Cost (after lock in) = 3.2% | Package B Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 3M SOR + 0.8%2 years lock in Legal subsidy 0.3%Cost (after lock in) = 3.1% | Package C Year 1: 1.2% (Fixed) Year 2: 1.6% (Fixed) Year 3: 2.3% Floating2 years lock in Legal subsidy 0.3%Cost (after lock in) =3.1% |

Assuming 3M SIBOR 0.8% and 3M SOR 0.6% |

Using this approach, we will rank Package B and Package C on par and Package A as the more expensive package. This is assuming that the borrower can refinance to a cheaper package in the 3rd year, therefore the cost to exit is higher in Package A.

To use this method correctly, you can filter the mortgages based on the lock in period first. Once that is complete, you will apply the formulae on the packages in their broad category.

As always Caveat Emptor