If I were to tell you that interst rates will stay at 1% range-bound for the next 6 years from 2021-2026, which will you choose?
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If that’s true, you will likely choose floating rather than paying fixed rate at 1.18-1.30% over the next two years only to realize that interest rates never come up? The problem is – no one has a crystal ball to gaze and predict the exact trajectory of interest rate in the next 6 years.
I put to you then that the best gauge is history itself – look at what happened when markets were flushed with liquidity after numerous rounds of QE (Quantitative Easing, or printing of money) from US Fed and other central banks all around the world. Rates stayed down from 2009 to 2014 and with no inflation to justify any monetary tightening or rate hikes. We have shown you the amount of QE unleashed this time around in our last article.
After the 2008 financial crisis, most homeowners would simply refinance or reprice from one SIBOR home loan to another for the lower promotional spreads for the first three years from 0.60-0.80% and 3-month SIBOR remained at 0.40% for long periods (see SIBOR chart). Pretty much no one was interested to lock themselves down on the higher fixed rates when rates were simply going nowhere. Of course, I am sure there will always be that small segment who wouldn’t mind paying slightly higher fixed rates at 1.25% for that peace of mind and the ease of paying a fixed amount every month. That little bit more could be $1,500 per year for a typical loan of $750,000, based on an average 0.20% premium for fixed rate over floating rate mortgages. Over a 2-year lock-in period that’s $3,000 more you pay the bank in interests. The absolute amount will be even more if your outstanding home loan is over $1m.
So, whether you choose fixed or floating in an interest rate environment that’s down and sideways for prolonged period (which we are about to enter into) depends a lot on size of your outstanding home loan which makes this the first factor out of six to consider.
1. Loan Quantum
It is logical to say that the smaller the outstanding loan, the lesser is the risk for overhedging on fixed rate. As the absolute amount of interest you will overpay is smaller, even if interest rate goes up unexpectedly while you are on floating rate. Hence, you would expect those with loans below $500,000 to go for floating rate. Conversely, those with bigger loans for example above $1m has got more to lose if their bets on floating go wrong and thus better for them to be on fixed rate home loan.
This is certainly the reverse of what we normally see on the ground where those with smaller loans tend to go for fixed rate whereas those above $1m tend to go for floating. For the latter, it is easy to see why as they will save more immediately by opting for floating rates at 1.00-1.05% today vs fixed rates at 1.18-1.20%. For a gap of about 15 basis points, that translates into savings today of $1,500 per year on a $1m loan. Take that bird in the hand, better than worrying about what’s still unknown tomorrow.
However, for the smaller loans especially those below $400,000, it may not be wise to go for fixed rate home loans. This is because when the fixed term of 2 or 3 years ends, interest reverts back to a floating rate usually at a much higher spread. Also, there will be higher overall costs involved in each subsequent rounds of refinancing or even repricing as smaller loans often do not get quoted favourable terms and will not get the full legal subsidy. Those on a smaller loan quantum might want to look at locking down a SIBOR or market-indexed floating rate home loan that comes with a low thereafter spread after the initial years.
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2. Own-use Vs. Investment Property
In general, if you have more than one mortgage to service and are thinking of opting for a fixed rate for one of them, then we advise you should fix the rate for the home you are staying in. This is because every cent that you are paying for the mortgage comes from your hard-earned income. On the contrary, investment properties come with rental income. As long as the rent can cover the interest component of the mortgage every month, you are just “paying yourself” by paying down the principal loan, even if the rate should rise.
In short, there is more leeway to accept the fluctuations of a floating rate mortgage for rented properties, as long as there’s rental to cover interest costs. You will also want the lowest interest rate possible for such a property in hope that the rent can cover more of the monthly repayment, if not all. Stretch the tenure to bring down the “carrying costs” further for such properties, as you probably do not mind taking a while longer to pay off the loan as long as it’s not “your money”. And there’s every chance you will sell it off earlier than planned. Hence, choose floating rate for investment properties especially when rates are now plateauing.
3. Flexibility To Sell Or Prepay
If you have plans to sell the property but would still like to lower the interest rate while it takes time for a sale to materialize, then go for adjustable rate home loan packages where the bank offers a waiver of penalty due to sale during the lock-in period. Some even allow you to prepay up to a certain percentage which makes it effectively like a “no lock” home loan where you can prepay or sell, except you can’t refinance out while locked.
Take note though on sale of the property within 3 years of taking up the loan, you are liable to pay back the legal subsidy (usually $2,000). Still, that’s a small fraction compared to the 1.50% penalty on the full loan amount redeemed as a result of a sale. Weigh the interest savings against the cost of returning this legal subsidy which is of course a factor of how long you estimate it will take for you to dispose of the property.
4. Certainty Of Income
The pandemic has heightened awareness of how extensive is the impact of digitalisation on businesses across many sectors. If you are in an area of work or industry that’s been threatened, you need to factor this uncertainty of income into your mortgage planning.
In general, as it may be harder to refinance later on without a job or with a reduced pay, you should opt for a floating rate home loan with the lowest thereafter spread when the lock-in ends. That may even be more important than getting the lowest headline interest rate for the initial years.
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5. Peace Of Mind
For those who have been observant, the banks have been touting this as the key selling point for a fixed rate home loan – it offers more stability and there’s no need to fear rising rates. Utter peace of mind. And that messaging plays well especially to the “kia-su” Singaporean mindset.
Even though we are generally preferring floating rates based on the point we are now at in the entire interest rate cycle, we do concede there’s an element of personality involved in the decision to go fixed or floating. So, the question becomes how much of additional interests I would need to pay in exchange for that peace of mind. And we have answered that earlier.
6. Your Outlook On Interest Rate
We’ve also covered this factor in a way at the start of this article. No one has a crystal ball but the best way to forecast on interest rate trajectory is to stare at the historical charts. Even for the layman, it’s not difficult to see how interest rate can never recover in a V-shaped pattern after each crisis. Stock market V-shaped yes, but not interest rate.
Since we are already back to the lowest point in the cycle, then the real question is how slowly would interest rate come up going forward or will it just stay flat for many years like in the last bust cycle? We have given our take on that.
There are those who still believe inflation will come up much faster than most thought and are preparing for rate hikes in the next few years or as early as 2022? Those with this outlook on interest rate will naturally want to go for fixed rate. Won’t it then make sense to go fixed rates for 3 years rather than 2 years, so as to really enjoy the benefit of hedging against rising rates? I will leave you to ponder that if you hold this view.
In our view, instead of trying to guess when rates will eventually rise, it’s even better to hedge at the point when rates are moving up definitively.
And how will you know when we have reached such a point after the many start-stops by the Fed (as we have already witnessed in the last up cycle)? Work with a trusted broker.
Since 2014, MortgageWise.sg has provided thought leadership in the mortgage planning space in Singapore, seeking to build trust with clients over the longer term rather than product-peddling for quick one-time deals. So, be it to refinance home loan, buy your next Singapore condo or even review your commercial property loan, speak to our dedicated team of mortgage consultants here for the best Singapore home loan rates.