From SOR/SIBOR to SORA interest rate benchmark, how would this affect your home mortgage loan?

Before the end of 2022, all SOR-based property loans would have transited to SORA interest rate benchmark. If you have an existing housing loan that is pegged to Singapore Dollar Swap Offer Rate (‘SOR’), your bank might have or will be contacting you about the need to move to a new loan package. In case you are wondering, this is a global situation and certainly not unique to Singapore. As a mortgage borrower on floating interest rate, you must be wondering why is there a need to switch and how would this impact your mortgage payments.

What Is the SORA interest rate benchmark?

SORA, administered by the Monetary Authority of Singapore (‘MAS’), is the volume-weighted average borrowing rate in Singapore’s unsecured overnight interbank cash market. I understand that this is quite a mouthful and probably too steeped in jargony. Therefore, I am going to break it down with an example as shown in Diagram 1.

For simplicity, assume that there are only 2 transactions that occurred in the overnight interbank cash market.

• Bank ABC lent $100m at 1% to Bank CBA
• Bank XYZ lent $20m at 2% to Bank ZYX

To account for the size of each transaction, we would need to apply the following formula: [(100m X 1%) + (20m X 2%)] / $120m =1.17%

Because SORA is volume weighted, the resulting interest rate of 1.17% is closer to 1% (the larger transaction) rather than 2% (the smaller transaction).

From the formula applied, it is evident that SORA is computed based on actual transacted data – i.e. overnight interbank cash market transactions. This makes SORA more reliable and transparent compared to its predecessors. Since you have understood the underlying formula of SORA now, you would also realise that it is “backward looking” rather than “forward looking” as “forward looking” is based on future estimates. Therefore, interest payments based on compounded SORA rates tend to be less volatile as it is based on interest rates over a period of time (eg: 1 month, 3 months or 6 months)

Why Are Banks Making You Switch to SORA?

Banks are asking borrowers with property loans pegged to SOR and SIBOR to convert because these reference rates will be phased out in 2023 and 2024 respectively. Naturally, new housing loans issued will also not be pegged to SOR nor SIBOR going forward.

Rather than running the risk of being overly technical again, let’s just simplify that these legacy interest rate benchmarks must be replaced because:

• either their underlying derivatives will be discontinued (for SOR) or
• their calculations are not always fully backed by transactions (for SIBOR)

If you compare the reasons above with your new-found understanding of how SORA is computed, you will appreciate why the Singapore banking industry is moving towards SORA as the new benchmark.

How Would Retail Borrowers Be Affected?

Having understood the need to convert your SOR or SIBOR-based housing loans, you must be wondering your finance would be affected with this mandatory crossover?

To begin, it is important to note that your SOR-based loan usually consists of 2 key components:

1. SOR Rate and
2. Margin applied by the bank

For those who are not familiar, Margin is the additional percentage that the bank earns from the borrower in addition to the cost of lending them the principal.

More importantly, SOR factors in the following:

a) Term Risk (to compensate for uncertainty over how interest rates may move over a future period of time), and

b) Credit Risk (to compensate for default risk faced by the bank)

Both these risks are not factored under SORA since SORA simply reflects the actual borrowing rate that banks in Singapore lend to each other at the overnight cash market. Therefore, a Retail Adjustment Spread have to be applied by the bank on a home loan that is pegged to SORA.

As shown in Diagram 2, this Retail Adjustment Spread is necessary to neutralise the conversion from a SOR-based loan to a SORA-based loan. It minimises the differences in interest payments at point of conversion.

What Choices Do SOR-based Or SIBOR-based Loans Borrowers Have?

If your existing home loan is pegged to either SOR or SIBOR, the window to take action to convert to alternative reference rates is narrowing on you. According to the Association of Banks in Singapore, property loan that references the SOR need to switch to an alternative loan package by 31 Aug 2022. If no action is taken by the borrower, they would automatically be converted to their bank’s SORA Conversion Package.

Armed with the information in this article, you may want to wrest control and decide the fate of your own mortgage loan. Besides opting for your bank’s SORA Conversion Package (which means you continue to stay on a floating loan package), you can also convert to the following types of loans as shown in Diagram 3:

1. Fixed-rate loans
2. loans pegged to other reference points such as the lender bank’s fixed deposit rates / board rates (eg: DBS Fixed Deposit Home Rate, OCBC Mortgage Board Rate etc)

At this juncture, I think it is important to pause and emphasise that it is important to speak to a professional mortgage broker/expert for unbiased customised advice at no cost to you.

The cynical you might also wonder if the banks would take this unprecedented opportunity to exploit this information asymmetry? To further equip yourself with more knowledge, you can check the website of Association Bank of Singapore which publishes the Adjustment Spread (Retail) on a monthly basis. Recall that this is referring to the difference that is applied to all retail SOR-based property loans that are converting to the SORA Conversion Package during that month.

What Is The Impact of Fed Hiking Interest Rates on SORA-based Loans?

While borrowers of SOR and SIBOR-based loans are juggling with the decision to convert to which type of loan package, they will be doing so under a macro environment that is experiencing the highest interest rate growth in decades. The Fed had just raised interest rates by 75 basis points (0.75%) and this brought the cumulative hike to 1.5% as at June 2022.

As Diagram 1 has illustrated, SORA is “backward looking” and hence borrowers on SORA-based loans will not experience interest rates rising prematurely in a manner that is not in sync with the US Fed Funds Rate. While it will take time for the increase to be funnelled through, there is no running away from it. Therefore, this is why I have reiterated at the start of the year that one of the best personal finance actions that you can take in 2022 is to review your existing mortgage and shop for the most competitive home loan package using PropertyGuru’s Smart Refi tool.

At the rate which Fed is raising interest rates, there is a closing window of time to refinance our properties to extract the most savings out of our monthly repayments. With inflation firing on all cylinders, I am sure your household budget will thank you for every little interest saving that you can extract from your HDB or condo.

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