Personal finance

How The World Is Slowly Trending Towards Fixed Deposit Mortgages

Buying a house is probably the single biggest financial commitment that most people undertake in their lifetime.

While homeowners would upgrade their homes from time to time, the number of home loans they have at any one time usually remains as one.

Banks know this and understandably compete very aggressively for customers as missing out on a prospect would very possibly mean that they miss out on the borrower forever, or at least for a decade or two.

Traditionally, housing loans are tagged to an index rate such as the LIBOR plus a spread.

But because of the volatility of indices since the 2008 financial crisis and the investigation into the LIBOR scandal of 2012, more and more homeowners have a negative perception of the LIBOR index.

On the lending side, unpredictable fluctuations of LIBOR have also left lenders with challenges in their own internal financial forecasts and planning.

This is because corporations need stability to make dependable financial projections so as to craft their own corporate strategies.

In recent years, a type of mortgage is slowly making headway into the real estate market.

These are home loans that use a time deposit rate as an index for mortgage interest rates rather than the conventional LIBOR.

While there are no general time deposit rates that apply to all banks, they basically refer to an average of consumer interest rates on fixed deposits over a given period of time.

For example a home loan might have an interest rate made up of TDR24 plus 1%. The TDR24 would mean fixed deposit interest that consumers would earn for placing their funds into a time deposit account for at least 24 months. If the interest earned is 2%, then the interest rate on the debt would become 2% + 1% = 3%.

The benefits of such types of structured loans are two-fold.

Firstly, the bank gets more control over what rate is eventually charged to homeowners. This is because time deposit interest rates are pretty much determined by a lender itself depending on variables of how they forecast the economy..

This shields them from any unexpected shocks that can throw their whole budget into question.

Moreover, using depositors’ offered to depositors as a benchmark for home loans, they effectively make it more simple to calculate their costs of funds. Essentially, the spread of such loans become their gross profit because the time deposit index used is similar to the interest offered to depositors.

A different angle to look at this is that the funds deposited by consumers is used to lend out to homeowners at the same price… plus the spread.

Secondly, homeowners can be assured that they are no longer under the stress of constantly tracking unpredictable index movements.

However, what they do give up is the potential of lenders driving up their own fixed deposit rates as they have control over it. The counter to that argument is that should lender indeed increase the time deposit rate used for home loans, it would effectively also mean that they are giving out higher interest rates to depositors… canceling out the increased rate charged to mortgage borrowers. This would defeat the whole purpose of increasing the time deposit index.

For all the positives of such home loans, time deposit linked interest rates are still in it’s infancy in the grand scheme of things. But there is indeed a trend being observed that more and more lenders are moving towards that direction simply because it solves some big problems faced by both borrowers and lenders within the market.

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March 21, 2020