As US Fed has hiked rates three quarters in a row since last December with interest rate poised to rise up second half of the year, many homeowners and property investors are wondering if they should switch to a fixed rate mortgage at a slightly higher rate than prevailing floating rate pacakges, especially if their lock-in period is expiring in the next couple of months.
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There are many arguments for choosing a fixed rate home loan, chief of which is the peace-of-mind that comes with a fixed monthly repayment amount come what may. However, some may have also heard of cases when someone ends up paying too high a fixed rate like 2.50% p.a. for too long during which time prevailing rates actually come crashing down notwithstanding anticipated uptrend. The decision is further complicated by the many uncertainties present in global ecomomies with seemingly shorter business cycles and shock outcomes from events around the world like Brexit and US Presidential Election which lead people to wonder what would happen next.
There is no easy answer or a one-size-fits-all solution, but as consultants in the field of mortgage planning, here’s what we think are 6 vital areas of consideration that one needs to run through in order to arrive at the best response based on one’s unique situation:
1. Investment Versus Own-Use Property
Question: If mortgage interest is at 5%, would you be more inclined to pay if this is for an investment property as opposed to one for the roof over your head ie. your owner-occupied home?
No doubt different people might respond differently but I would argue that it will be somewhat less painful for one to pay high interest for an investment property as theoretically there should also be good rental income (in an exuberant and expansionary economy for interest to trend up) to help defray that cost. Especially when the rental income is at least sufficient to cover the interest component of the monthly repayment. By opting to pay a higher “carrying cost” for the underlying property, the investor is also looking to profit from a much higher capital appreciation when he finally offloads it. The key here comes down to cashflow management and not just the absolute interest rate per se.
In this regard, a floating rate which drifts up and down in accordance with economic indicators may not be such a bad idea. Not to mention floating rate mortgage comes with greater flexibility with no lock-in periods, unlike fixed rate home loan which comes with fresh commitment period each time one refinances. All the transaction costs involved for refinancing whenever a fixed rate term ends, plus potential legal fee clawback and lock-in penalty suffered will eat into and erode the investor’s profit margin when a rich buyer appears when least expected with that irresistible offer.
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2. Size Of The Outstanding Mortgage
Many mortgage consultants out there missed this all-important point altogether. They just recommend their clients to go fixed rate as the “safest option”. We think it may not always be the best option, as size really does matter. Ironically it is those with smaller outstanding mortgages that tend to ask for and prioritize fixed rate over the rest. We often have to go on an educational exercise to show them, using our in-house Interest Simulator tool, that under the assumption of a very gradual rate hike environment, the total costs involved in going for fixed rate outweighs the resulting savings if any. They are actually better off on a floating rate mortgage with a low long-term spread. The key here is to pick the home loan peg with the least propensity to rise up (last few to move) and that is the exact forte of our consultants who have much to share with you our in-house tracking and analysis.
3. One’s Income Situation In The Next Five Years
With TDSR (Total Debt Servicing Ratio) which is structural and here to stay (even if all other cooling measures are removed over time), this becomes an important consideration. If one goes for fixed rate which often reverts to a much higher floating rate when the fixed term ends in two to three years, one may find himself in a predicament where he is unable to refinance when he loses his job or gets his income cut.
If one detects headwinds in his industry, contrary to what most would do which is to pay down the loan quickly using idle funds, we think the contrarion approach makes more sense – maximize leverage while one still can. Creating this surplus fund is important for a few reasons and one of them relates to the next point below on the ability to generate good returns for retirement. And the best part, there are interest-offset mortgage accounts out there that allows one to set aside this surplus fund but without paying unnecessary interest costs until the funds are deployed for investment or for rainy days (this is only for private properties). Think about it. Where else can one borrow commercially at relatively stable long-term interest rate below 3.5% p.a. for prolonged period? Do it while one is still able to, however that requires one to be on a floating rate package and it also means ability to service a higher monthly repayment amount. Speak to our consultants who can explain to you more.
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4. Ability To Generate Good Returns
Whether one chooses fixed or floating rate home loan, the ability to make use of good leverage is critical for retirement in an expensive city like Singapore. And if one is relatively young and has a stellar career with minimal risk of being displaced from the job market, going for fixed rate just when interest is about to shoot up will help to multiply investment returns further by keeping cost of funds down.
We are not financial advisors here but with fixed rate currently hovering at below 2% (starting from as low as 1.48% in first year), the probability of leveraging up on a mortgage to earn returns of between 3% to 5% p.a. by assuming some reasonable risk is good. This is especially true in Singapore where it has established itself as a financial hub for REITS in Asia in the last 10 years, and is now even attracting asset owners from around the world like US to list their REITS here.
Caveat Emptor. Every investment carries risk. As this is serious money for retirement purpose, the old investment adage applies – never lose the capital or principal sum. And unless one is prepared for the risk involved, never use leverage for seemingly high-yielding investments like crowdfunding, bonds, structured notes, hotel rooms, etc. Protect capital at all costs. To this end, we cannot think of anything else other than blue chip securities listed in one’s own name with CDP or property titles registered with SLA. Even for the former, we are not sure if it will work if one ends up buying blue chips at the wrong point of the business cycle. Exercise caution. We recommend buying the three local bank stocks as a form of hedge against rising mortgage interest, but only when the market corrects substantially.
5. The Ability To Do Partial Paydown
Another consideration for going on fixed or floating rate home loan is the ability to do partial paydown should the pace of rate hikes be too quick for one’s liking. There are many homeowners we know of who have built up significant funds in their CPF Ordinary Account as they have opted to service their mortgage using cash in the last decade when mortgage rate hovers in the 1% to 1.20% p.a. range. This makes perfect sense when CPF is paying compounding risk-free interest of almost double that at 2.50% p.a. Even today we still have floating rates from as low as 1.25% p.a. and for those who are gainfully employed with good cashflow every month it may not be too late yet to switch to cash mode for mortgage servicing.
If one has huge surplus funds both in CPF and cash built-up over the years, there is less risk involved in going for a floating rate package as the consensus is for interest to rise up at snail pace over the next few years. In fact experts have warned of a “lower-for-longer” interest rate environment this decade with a greying world population and with technologies disrupting jobs and wage growth.
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6. Outlook On Interest Rate (And The Gap Between Fixed And Floating Rate)
Finally one’s outlook on interest rate undoubtedly will carry the most weight in this debate. Here one needs to also look at the gap or differentials between the lowest floating (now at 1.28% on FDR home loans) and fixed rate (average 2-year fixed at 1.55%) at the point of taking up a mortgage. Right now this gap is around 0.27% (1.55% minus 1.28%) which can be closed with just one single rate hike or when SIBOR moves up by 30 basis points. Hence the question one needs to answer is how soon will that happen and if the savings on floating rate package is substantial enough to warrant such a bet. This lead to other considerations like lock-in periods on a floating rate mortgage which can be hugely detrimental should one’s bet turn sour and finds himself “trapped” in an escalating interest rate package. Penalty of 1.5% of the loan amount will still apply even if one reprices to fixed rate package in the same bank during the lock-in period.
Speak to our experienced consultants today who can help you make the best decision for your next home loan before signing on the dotted line.
At MortgageWise.sg, we seek to provide thought leadership in the area of mortgage planning in Singapore, taking deep dive into developments and news on mortgages & helping clients track interest rate movements. We do not just go for one-time business with clients but rather choose to build long trusting relationships by giving truly independent advice to the extent of losing the deal. We strive to become the first-choice mortgage partner for homeowners and the creditable distributor of mortgage products for banks and financial institutions in Singapore.