Mortgage rates often appear lower in the earlier years and higher in later years due to how interest is calculated and the structure of most mortgage repayment schedules. Here are the key reasons for this phenomenon:
1. Declining Balance and Interest Calculations
Mortgages typically use amortization, where each monthly payment includes both interest and principal repayment.
- In the early years: The outstanding loan amount (principal) is highest. As interest is calculated as a percentage of the outstanding principal, the interest portion of each payment is larger, while the principal repayment is smaller.
- In later years: As you pay down the principal, the outstanding loan balance decreases, so the interest portion becomes smaller, and more of your payment goes toward the principal.
While this doesn’t increase the actual interest rate, the borrower may perceive rates as “higher” in later years because of how repayments are structured.
2. Promotional Rates
Many banks offer promotional rates (lower rates for the first few years) to attract borrowers.
- Why banks offer them: Promotional rates are designed to make home loan interest rates much lower in the early years, encouraging borrowers to sign up.
- What happens after the promotional period: Once the initial period ends (e.g., 2-3 years), the mortgage shifts to a standard or higher floating rate tied to market benchmarks, resulting in higher interest payments.
3. Floating Rates and Market Movements
For loans with floating rates, the interest rate fluctuates based on benchmarks like the Singapore Overnight Rate Average (SORA).
- Early years: If rates are low due to favorable market conditions, borrowers enjoy smaller interest payments.
- Later years: If rates rise due to economic changes (e.g., inflation or central bank policies), mortgage payments increase.
Borrowers often see rising rates over time if interest rate benchmarks increase.
4. Progressive Payment for BUC
For buyers of properties under construction (e.g., Build-To-Order flats or condominiums), payments are structured progressively.
- During the construction phase: Borrowers only pay interest on the disbursed amount, which is lower in the early stages.
- After full disbursement: Once the property is completed, the loan amount is fully disbursed, and borrowers start paying both principal and interest, which can feel like a higher “rate.”
5. Inflation and Long-Term Costs
Over time, inflation can erode the value of money, making the “real cost” of borrowing appear higher. Additionally:
- Borrowers might feel the impact of increased rates more acutely as their other expenses grow with inflation.
- If refinancing options are limited in the later years, borrowers may be locked into higher rates.
6. Prepayment Impact
In the early years, prepaying your mortgage has a larger impact on reducing total interest costs, as the principal is still large. In later years, prepaying has less impact because most of the interest has already been paid, which might make borrowers feel like they’re paying more in effective terms.
Summary
Mortgage rates seem lower in the earlier years due to promotional offers, amortization schedules, and lower initial balances. They can feel higher later due to market fluctuations, promotional periods ending, or progressive payment structures. Borrowers should carefully evaluate the loan terms, including potential rate increases, and consider refinancing options to manage costs over the life of the loan.
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