With rising energy prices and the threat of inflation more keenly felt than before, there is growing concern that U.S. Fed may be forced to quickly taper and even “lift off” in interest rates sooner than expected by 2^nd half of 2022.  Is there still a case for choosing the lower floating rate home loans over fixed rate?

Indeed, more people are scurrying for fixed rate right now for three reasons:

The gap between fixed and floating is too small

Depending on the loan amount, current floating rate home loans pegged to the new interest benchmark of 3-month compounded SORA (Singapore Overnight Rate Average) hovers in the range of 0.80%-1.00% for the first two years.  Whereas that for a 2-year fixed rate is at 1.05% to 1.20%.  For a typical private property home loan of $750,000, this gap between the lowest floating and lowest fixed rate home loan is as close as 0.10%.  With such a small gap, it makes sense to lock down a fixed rate as a hedge without much opportunity costs.

Interest rate at all-time low

With interest rate at a historical low (see our chart below on interest rate cycle), the only way for rates to move from here will be either up or sideways.  Put it another way, you can’t quite go wrong with a fixed rate at a historical low in Singapore.

Fixed rate packages with waiver of penalty on sale

With a buoyant property market, many may want to retain the option to sell their property without incurring a hefty 1.50% penalty when the mortgage is redeemed within the lock-in period.  It used to be banks only provide waiver of such penalties due to sale only for floating rate home loans.  However, with stiff competition in a free market, a few of the smaller lenders are dangling this waiver as a loan feature even for fixed rate mortgages. 

Put it another way, you can’t quite go wrong with a fixed rate at a historical low in Singapore.

Does this mean that there is no merit in opting for a floating rate mortgage?  Being in the mortgage business for close to a decade, we’ve witnessed many twists and turns in the cycle to learn this: expect the unexpected.  Covid-19 pandemic itself is an unexpected black swan event, probably once in a lifetime.  U.S. Fed’s tapering and ensuing rate hikes (if it happens) do not necessarily mean that interest rate will spike up in a straight line without bumps along the way.  In fact, our experience shows that most clients who opt for fixed rates, especially those with very long fixed term like 4 or 5 years, tend to overpay in the end.

To help you make that decision, it’s important to consider 6 factors when choosing between fixed and floating rate home loans:

1. Interest rate cycle

This is perhaps the most important factor.  And we’ve covered why most homeowners favour fixed rate home loans right now – the small gap as well as the fact that we are coming out from the lowest point in the cycle.

Where are we now in interest rate cycle is probability the most important question to ask when it comes to mortgage planning.  Signing onto a fixed rate at the start of an ascent or at a late-stage nearing a peak carries markedly different risks.  Likewise, opting for a floating rate home loan pegged to SORA when we are near a cycle peak make seem silly at first, but pays huge dividends when the cycle reverses and SORA comes crashing down.

U.S. Fed’s tapering and ensuing rate hikes (if it happens) do not necessarily mean that interest rate will spike up in a straight line without bumps along the way.  In fact, our experience shows that most clients who opt for fixed rates, especially those with very long fixed term like 4 or 5 years, tend to overpay in the end.

2. Sale of property

Will you be selling the property within the next 1-2 years? We have explained earlier: waiver of penalty due to sale is not a standard feature for fixed rate mortgages.  Most lenders tend not to offer that.  So, if you are planning to sell, you’ll probably have more options on floating rate packages where some also come with one-year lock-in.

3. Investment vs owner-occupation

Somewhat related to the need to sell is the nature of use of the mortgaged property.  Investors will want to retain the option to sell at all times as you never know when the good offer will come, or when there’s sudden need to offload due to vacancy periods or changes in one’s financial situation.  Thus in general, it’s logical to mortgage investment property on a floating rate home loan which comes with penalty waiver.  You’re also more prepared for some fluctuations in interest rates when there’s rental income to help with repayments.

4. Flexibility to prepay

Most are unaware that regular prepayments with your spare cash do much more to reduce interest costs than refinancing.  Go for floating rate home loans if you like to keep that flexibility to prepay especially if you are expecting good bonuses to be paid out in the next few years.

5. Size of the outstanding loan

This is a double-edged sword.  When the outstanding loan is huge, there’s much more to profit from a lower floating rate than fixed.  At the same time, there’s also much more to lose should interest rate rise up faster than expected.  Which perspective is correct?  In a “lower for longer” interest rate environment post-2008 since QE (quantitative easing or money-printing by U.S. Fed) started, we tend to favour the former – the bigger the loan quantum, the more merit to consider a floating rate home loan.

6. Stability of income

This is important as fixed rate home loans often revert to a floating rate with a higher spread (the margin for banks above SORA) when the fixed term ends.  If you are in an industry susceptible to disruptions, or you sense headwinds in your job, or you are contemplating a career change; it’s better to keep to a floating rate with a low or acceptable spread throughout the loan tenure.  This circumvent the need for constant refinancing.  You’ll pay higher interests in some years but you’ll also pay lower interests when the cycle turns – it evens out. Not to mention you also save on paying all the repricing admin fees.

In a “lower for longer” interest rate environment post-2008 since QE (quantitative easing or money-printing by U.S. Fed) started, we tend to favour the argument – the bigger the loan quantum, the more merit to consider a floating rate home loan.

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