How Does A Home Loan Really Work?

Banks often publicize their housing loan interest rate, but they seldom explain the workings of a loan for home. While a housing loan is not very simple to understand, it isn’t rocket science either. In this article, we try to explain the workings of a housing loan, but first, you need to understand a few key terms:

Principal of a Housing Loan:

The principal of a housing loan is basically the amount borrowed and not yet repaid. For housing loans, interests are usually charged on this principal amount.

Housing Loan Interest Rate:

Interest rates for housing loans in Singapore are usually quoted as a fixed rates or SIBOR + a fixed value, in case of floating interest loans. For example, a floating rate loan could be quoted as SIBOR +1.25%.

Loan Tenure:

The loan tenure is simply the agreed length of a housing loan. In Singapore, homebuyers can take out housing loans with tenure of up to 35 years.

An Example:

Let’s assume you’re about to take out a home loan of SGD200,000 for 30 years, at an agreed interest rate of 1.75%. We also assume for the purpose of this example, that the rate is fixed for 5 years and then it’s estimated to be SIBOR +0.5% and SIBOR keeps stable at 1.25% for the whole duration. (Please note that in Singapore the fixed rate is fixed only for 1st few years and thereafter is pegged to Singapore Interbank Offer Rate (SIBOR)

Illustration:

Home Loan Amount: SGD200,000

Interest Rate: 1.75% per year

Loan Period: 30 years

Interest and Monthly Repayment Calculation:

The interest on all home loans in Singapore is calculated monthly. In this case, the 1.75% yearly would equate to a monthly installment of $714.49. However, out of 8473.88 dollars paid in the 1st year, the interest payment in the 1st year to be $3459.11.

This rest of the payment goes into bringing down the loan principal (what you owe on your home loan).

As your home loan interest is calculated based on what your principal, the interest on your loan from the second year onwards will be slightly lower.

In calculating the monthly amount you’re required to pay, banks use a formula called an “amortization formula”. This formula helps in calculating your monthly payment amount and works in such a way that by the time you get to your last payment (based on your agreed loan term); you would completely pay off your loan and all the due interest.

The monthly repayment amount usually remains the same for the entire term of your loan.

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