Dear Mr Tan,
Is it better to take a mortgage on a fixed rate, or a floating rate?
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REPLY:
It depends on the terms that are offered to you. Normally, the interest rate should be pegged to a market benchmark plus a margin.
For example, the interest rate on 10 year government bond is now at 3% p.a. A fixed rate mortgage should be at 3% plus a margin of say 1%, ie 4% p.a. It should be fixed for the full term.
The floating rate should be based on the current rate of (say) 2% plus the margin of 1%, ie 3%. This interest rate should be reset every 6 to 12 months, based on the movement of the market benchmark.
At the current time, when interest rate is at a historically low level, it is better to take a fixed rate loan and pay 4% p.a (say) for the next 10 years. You do not have to worry about future changes in the interest rate, as this rate is "locked in".
Apart from any special reason (eg lock in the current interest rate), I generally prefer a floating rate. This gives the greatest flexibilty for you to re-finance the loan, to repay the loan early (when you sell the property) or to change your repayment schedule.
Monday, July 2, 2007
Different types of mortgages
Source: Wikipedia
1. Adjustable rate mortgage (ARM). The interest rate on the loan is periodically adjusted based on an index. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change).
Adjustable rates transfer part of the interest rate risk from the lender to the borrower. The borrower benefits if the interest rate falls and loses out if interest rates rise. Adjustable rate mortgages are characterized by their index and limitations on charges (caps).
2. Graduated payment mortage (GPM). It has low initial monthly payments which gradually increase over a specified time frame. These plans are mostly geared towards young men and women who cannot afford large payments now, but can realistically expect to do better financially in the future.
3. Interest only mortgage. During the agreed term, the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the term the borrower may enter an interest-only mortgage, pay the principal, or convert the loan to a principal and interest payment (or amortized) loan.
4. Fixed rate mortgage(FRM). The interest rate on the loan remains the same through the term of the loan. Fixed rate mortgages are characterized by their interest rate, amount of loan, and term of the mortgage.
5. Negative amortization mortgage. The borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender. Such a practice would have to be agreed in advance, to avoid default on payment.
6. Balloon payment mortgage. This mortgage does not fully amortize over the term, leaving a balance due at maturity. The final payment is called a balloon payment. This mortgage may have a fixed or a floating interest rate.
A "two-step" mortgage plan may be used with balloon payment mortgage. Under this plan, sometimes referred to as "reset option", the mortgage "resets" using current market rates and using a fully-amortizing payment schedule. If there is not reset option, the borrower is expected to sell the property or refinanced the loan.
1. Adjustable rate mortgage (ARM). The interest rate on the loan is periodically adjusted based on an index. This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change).
Adjustable rates transfer part of the interest rate risk from the lender to the borrower. The borrower benefits if the interest rate falls and loses out if interest rates rise. Adjustable rate mortgages are characterized by their index and limitations on charges (caps).
2. Graduated payment mortage (GPM). It has low initial monthly payments which gradually increase over a specified time frame. These plans are mostly geared towards young men and women who cannot afford large payments now, but can realistically expect to do better financially in the future.
3. Interest only mortgage. During the agreed term, the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the term the borrower may enter an interest-only mortgage, pay the principal, or convert the loan to a principal and interest payment (or amortized) loan.
4. Fixed rate mortgage(FRM). The interest rate on the loan remains the same through the term of the loan. Fixed rate mortgages are characterized by their interest rate, amount of loan, and term of the mortgage.
5. Negative amortization mortgage. The borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender. Such a practice would have to be agreed in advance, to avoid default on payment.
6. Balloon payment mortgage. This mortgage does not fully amortize over the term, leaving a balance due at maturity. The final payment is called a balloon payment. This mortgage may have a fixed or a floating interest rate.
A "two-step" mortgage plan may be used with balloon payment mortgage. Under this plan, sometimes referred to as "reset option", the mortgage "resets" using current market rates and using a fully-amortizing payment schedule. If there is not reset option, the borrower is expected to sell the property or refinanced the loan.
Adjustible Rate Mortgage
Source: About.com
An adjustable rate mortgage (ARM for short), is a mortgage with an interest rate that is linked to an economic index. The interest rate, and your payments, are periodically adjusted up or down as the index changes.
Index
An index is a guide that lenders use to measure interest rate changes. Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others. Each ARM is linked to a specific index.
Margin
Think of the margin as the lender's markup. It is an interest rate that represents the lender's cost of doing business plus the profit they will make on the loan. The margin is added to the index rate to determine your total interest rate. It usually stays the same during the life of your home loan.
Adjustment Period
The adjustment period is the period between potential interest rate adjustments.
---------------------
NOTE:
Most of the mortgages in Singapore have adjustible rate. However, in the past, they are based on the board rate decided by the lender. Recently, some lenders have introduced loans with rates that are linked to a market benchmark (ie similar to the ARM in America).
An adjustable rate mortgage (ARM for short), is a mortgage with an interest rate that is linked to an economic index. The interest rate, and your payments, are periodically adjusted up or down as the index changes.
Index
An index is a guide that lenders use to measure interest rate changes. Common indexes used by lenders include the activity of one, three, and five-year Treasury securities, but there are many others. Each ARM is linked to a specific index.
Margin
Think of the margin as the lender's markup. It is an interest rate that represents the lender's cost of doing business plus the profit they will make on the loan. The margin is added to the index rate to determine your total interest rate. It usually stays the same during the life of your home loan.
Adjustment Period
The adjustment period is the period between potential interest rate adjustments.
---------------------
NOTE:
Most of the mortgages in Singapore have adjustible rate. However, in the past, they are based on the board rate decided by the lender. Recently, some lenders have introduced loans with rates that are linked to a market benchmark (ie similar to the ARM in America).
Look for good advisers
COMMENT POSTED IN MY BLOG:
I would like to add that the agents sell what pays them the most commissions besides what is hot (typically what is bad for the investor).
Most are driven by sales commissions. If the client so happens to buy something good for themselves, it is just pure luck.
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REPLY:
There are advisers (agents) who sell low cost products that are good for the investors. They get a modest commission and provide good service to their clients.
I would like to add that the agents sell what pays them the most commissions besides what is hot (typically what is bad for the investor).
Most are driven by sales commissions. If the client so happens to buy something good for themselves, it is just pure luck.
------------------------
REPLY:
There are advisers (agents) who sell low cost products that are good for the investors. They get a modest commission and provide good service to their clients.
Lorenzo de Medici
I watched an interesting documentary about Lorenzo de Medici in the History Channel 8 on Starhub. I searched Wikipedia and found the following:
Lorenzo de' Medici (January 1, 1449 – 9 April 1492) was an Italian statesman and ruler of the Florentine Republic during the Italian Renaissance.
Known as Lorenzo the Magnificent (Lorenzo il Magnifico) by contemporary Florentines, he was the most remarkable public figure of his time. Not only a wily diplomat and politician, he headed a brilliant group of scholars, artists, and poets. He was charismatic, tough, passionate, and energetic, equally devoted to his city, his family, the church, and the pursuit of art and learning.
His life coincided with the high point of the early Italian Renaissance; his death marked the end of the Golden Age of Florence.
The fragile peace that he helped to maintain between the various Italian states collapsed with his death; and two years later the French invasion of 1494 began nearly 400 years of foreign occupation of the Italian peninsula.
Though the Medici remained in power in Florence for several centuries, producing three popes and two queens of France, none of his successors approached Lorenzo's range of interests and accomplishments or the generosity of his vision.
Tip: Watch Starhub Channel 8 (History Channel). It is quite interesting.
Lorenzo de' Medici (January 1, 1449 – 9 April 1492) was an Italian statesman and ruler of the Florentine Republic during the Italian Renaissance.
Known as Lorenzo the Magnificent (Lorenzo il Magnifico) by contemporary Florentines, he was the most remarkable public figure of his time. Not only a wily diplomat and politician, he headed a brilliant group of scholars, artists, and poets. He was charismatic, tough, passionate, and energetic, equally devoted to his city, his family, the church, and the pursuit of art and learning.
His life coincided with the high point of the early Italian Renaissance; his death marked the end of the Golden Age of Florence.
The fragile peace that he helped to maintain between the various Italian states collapsed with his death; and two years later the French invasion of 1494 began nearly 400 years of foreign occupation of the Italian peninsula.
Though the Medici remained in power in Florence for several centuries, producing three popes and two queens of France, none of his successors approached Lorenzo's range of interests and accomplishments or the generosity of his vision.
Tip: Watch Starhub Channel 8 (History Channel). It is quite interesting.
Life cycle funds
Source: Investopedia
Even though the investment industry might have you think otherwise, investing for your retirement does not have to be difficult. Still, many people turn to investment advisors for help.
Unfortunately, because of how advisors are compensated, there may be conflict between what is best for them and what is best for their clients.
Life-cycle funds offer a viable solution. Here we'll examine what these funds are, compare different ones and finally look at some issues to consider before using these funds for your retirement portfolio.
What Are Life-Cycle Funds?
Life-cycle funds are the closest thing the industry has to a maintenance-free retirement fund.
Life-cycle funds, also referred to as "age-based funds" or "target-date funds", are a special breed of the balanced fund. They are a type of fund of funds structured between equity and fixed income.
But the distinguishing feature of the life-cycle fund is that its overall asset allocation automatically adjusts to become more conservative as your expected retirement date approaches. While life-cycle funds have been around for a while, they have been gaining popularity.
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Example of asset allocation (Vanguard)
As the fund approaches the target maturity date, a higher proportion is invested in bonds.
Rule of thumb: The proportion invested in bonds should be equal to your age!
Even though the investment industry might have you think otherwise, investing for your retirement does not have to be difficult. Still, many people turn to investment advisors for help.
Unfortunately, because of how advisors are compensated, there may be conflict between what is best for them and what is best for their clients.
Life-cycle funds offer a viable solution. Here we'll examine what these funds are, compare different ones and finally look at some issues to consider before using these funds for your retirement portfolio.
What Are Life-Cycle Funds?
Life-cycle funds are the closest thing the industry has to a maintenance-free retirement fund.
Life-cycle funds, also referred to as "age-based funds" or "target-date funds", are a special breed of the balanced fund. They are a type of fund of funds structured between equity and fixed income.
But the distinguishing feature of the life-cycle fund is that its overall asset allocation automatically adjusts to become more conservative as your expected retirement date approaches. While life-cycle funds have been around for a while, they have been gaining popularity.
-------------------------------------
Example of asset allocation (Vanguard)
Target Equity Bond
maturity
2025 59% 41%
2015 51% 49%
As the fund approaches the target maturity date, a higher proportion is invested in bonds.
Rule of thumb: The proportion invested in bonds should be equal to your age!
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