The fixed deposit home loan rate (FHR) is a board rate offered in mortgages by DBS.
It is calculated by taking the average of prevailing fixed deposit rates for specified tranches of fixed deposits.
The two main published variable of FHR are the period of fixed deposits (FD) and the amount which is often observed to be $1,000 to $9,999. With the bank reserving the right to make changes as and when they deem necessary.
For example, FHR8 refers to the average of interest rates on 8-month fixed deposits on the deposit amount of between $1,000 and $9,999.
There is no clear explanation of how the dynamics of how FHR works.
But in the case of FHR8, it might be that all the 8-month fixed deposit accounts for amounts within $1,000 and $9,999 are collated. The interest rates on these accounts are then tabulated. And the average interest rate of all these accounts are calculated by a simple formula of:
Total Interest / Number of Accounts
This can easily make sense to even the average home owner.
How FHR is applied to home loans
Considering that DBS is the biggest consumer bank operating in Singapore, it’s products and offerings are often very well received simply due to the exposure that they enjoy consumers.
FHR is mostly applied to home loans when property buyers need financing for their purchase of new and resale property, and when homeowners are seeking a new home loan to replace their current ones with refinancing.
Home loans are structured with FHR as the base rate (or index rate) plus a spread which would make up the total interest that would be charged on the housing loan.
For example, when FHR8 is 0.95% and the spread is 1.25%, then the total interest rate on the home loan would be FHR8 + 1.25% = 2.20%.
When FHR8 adjusts according to market forces or when the bank decides to, then the mortgage rate on the loan would adjust accordingly with the new base rate plus the spread.
For fixed rate home loans, a mortgage package would have a period of fixed interest rates for the first initial few initial years of the loan without any influence by FHR.
However when the period of fixed rate expires, the interest rate structure would be reverted to a typical FHR plus spread. The borrower would then be exposed to the risks of fluctuating FHR.
FD rates as component of mortgage rates
In essence, banks are in the business of obtaining access of money for a fee, and then lending out the money to borrowers at a premium. The difference would be the gross profit.
One of the ways that banks gain access to funds for lending is through savings deposits and fixed deposits.
This means that when home loan interest rates are tied to fixed deposits interest rates, it can be deduced that funds collected from fixed deposit accounts are used to lend to mortgage borrowers to finance their properties.
So if a loan is on FHR + 1% for example, the implication of this is that borrowers are essentially paying for the interest that the bank pays to depositors, with the 1% spread collected by the bank as gross interest revenue.
If FHR is 0.75%, this 0.75% essentially represents the costs of credit incurred by the lender.
An in effect, a borrower would be paying the cost of credit being 0.75% and an additional 1% as interest revenue.
The interest rate on a home loan would be guaranteed to cover the cost of credit.
It is a situation where the banks cannot lose.
Whereas, with an index rate like SIBOR used as the base rate, volatile fluctuations can still mean that the bank’s gross revenue (in percentage points) can vary from time to time.
These reasons are probably why any bank would have no issues with lending as many home loans as possible consisting of a fixed deposit rate as the base rate.
FHR vs other index rates
The fixed deposit home rate has some key advantages over other types of index rates.
It’s no coincidence that FHR is one of the most popular types of home loans. This is reflected that after pioneering this base rate, other banks started to follow suit with their own versions of fixed deposit rates.
Most homeowners with current housing loans that were underwritten many years ago would have their loans pegged to SIBOR as the base rate.
As SIBOR is calculated with components that depend on local and global economic factors, it can fluctuate unpredictably and cause borrowers sleepless nights.
For example, SIBOR has a history of hitting an all time high of over 9% and a 1MSIBOR has been recorded to have gone dangerously close to zero.
This wide band of fluctuation can be annoying to many home owners who seek nothing less than stability and predictability on their home loans and repayments.
The SOR which was also one of the more popular index rates in the not so distant past was known for it’s even more erratic behavior.
It was partly due to these instability of indices that the FHR was introduced.
FHR is determined heavily by the interest rates offered to consumers via fixed deposits.
These interest rates offered to consumers don’t change as often as index rates such as SIBOR. And when they do change, the adjustments are seldom dramatic.
As FHR is controlled by the bank, and therefore classified by many experts as indirectly a board rate, the bank has the power to control the volatility of home loan interest.
The argument against that feature as a benefit is that borrowers who chooses a FHR loan would be at the mercy of the bank as they would have the right to increase FHR as and when they like.
But the counter-argument to that is that should the lender raise FHR, they would then raise the interest expense that they have to payout to fixed deposit customers.
So they would think twice before raising FHR for no good reason.
What would cause FHR to rise
To understand what would cause FHR to rise, one must be able to comprehend the basic principles of the global financial system.
Since FHR is pegged to the interest rates offered to consumers on fixed deposits, the rise of fixed deposit rates would drag FHR upwards.
There are some well-known economic events that can cause that to happen.
Rise in bond rates
When the yield on treasury bonds rise, investors would be tempted to move their funds to the bond market for better returns.
To attract investors to put or keep their funds in fixed deposit accounts, banks would offer better deposit rates.
This means that the mechanics of how bond coupon rates fluctuate would indirectly impact the interest rates offered on fixed deposits, and therefore, FHR.
Interbank rates
SIBOR is the interest rate that banks lend to one another.
If the index is low, then the bank would have access to cheap money.
It would therefore be unnecessary to offer high fixed deposit rates to entice depositors to hold their excess funds with the bank.
This would theoretically push down interest rates on fixed deposits.
The same concept should apply concerning interest rates offered by the central bank to lenders. When it falls, deposit rate should theoretically follow suit.
Demand and supply of money
All the movement of interest rates effectively originates from the demand and supply of money from the banks perspective.
When there is a lot of credit and cheap money that a bank can get access to, there would be less of a need to raise fixed deposit rates to bring in funds.
And vice-versa.
However, it must also be noted that banks have reserve requirements to meet in order to adhere to MAS regulations.
For example, to order to meet the requirements of the reserve requirement ratio and net stable funding ratio (NSFR), banks might have to bring in more deposits to improve their ratios so as to meet requirements.
The more they need funds to meet these requirements, the higher fixed deposit rates can become.
Should you take a FHR home loan?
While FHR home loans are very attractive, the decision of whether to apply for, or accept one really depends on the needs of the borrower and how his/her decision process works.
Many borrowers for example, predict what is likely to happen to interest rates in the future, and let that one factor heavily influence their mortgage selection.
Those who feel that interest rate hikes are on the horizon might choose fixed rate mortgages. While those who feel that interest rates would fall might prefer home loans linked to index rates like SIBOR that would better exploit that potential outcome.
FHR loans offer a stable and predictable play that can give a homeowner peace of mind. And even if interest rate rises, the chances of it becoming excessive and unaffordable are low due to the way FHR is structured.
If you simply have no preference over any type of loan or loyalty towards any particular bank, then avoid predicting the future and select an option that is presently the best might actually turn out to be a smart move.
This is because no one can predict the future.
And a good loan now has as good a chance as any other loan to continue being a good loan in the future.
