With unexpected slump in new job creation numbers in US last week, suddenly there seems to be a respite for homeowners from rising interest rates at least for next one to two months. With expectation of liftoff in rates by December originally, the market usually factors in before it happens and hence we can expect fixed rate to go above 2% very soon. Now there might be a longer window till end of the year for homeowners to quickly lock in the still-low fixed rates.

Several banks have in recent weeks extended their fixed rate promotion for another month, notably UOB home loans, OCBC home loans and CIMB home loans. The latter being the only bank that offers the longest fixed rate term of 4 and 5 years in Singapore. In this week’s article we explore the virtue of locking down fixed rate over a longer period as opposed to the usual 2 years offered by most banks these days. Does it make sense?

To answer that question in a more definitive and meaningful way we do really need to look at how several banks’ fixed rate loans at the moment stack up against one another. We also need to make some reasonable assumptions on the pace of interest rate increase in Singapore. For this study we will look at the case of private property refinancing.

Analysts are projecting US Fed to hike rates in the normal pace of 4 times a year over a period of 2 years with each round an increase of 25 basis points or 0.25%. This amounts to a 1% increase per year which is exactly what happened in the last up cycle. However to take a very conservative view, let us assume rate hike here in Singapore at half of this pace on a straight-line basis over the next 5 years, ie. 0.50% p.a. This is illustrated in the table below where we start 2016 (Year 1) with 3-month Sibor at 1.20 followed by a 50 basis points increase each subsequent year after that. Prevailing floating rate will be set at typical promotional margin of 0.80% above cost of funds Sibor, and fixed rates will command a premium of 0.20% above this prevailing floating.

Against this backdrop we then map out the simple average (ignore the effects of amortization) over a 5-year period for a homeowner who choose the lowest fixed rate packages of the day for 2-year fixed (UOB), 3-year fixed (Bank of China) and so on. We will assume that when the fixed rate term ends (for example UOB after 2 years), the homeowner will refinance over to another fixed rate package at the prevailing fixed rate (in this case by year 3 the fixed rate will be at 3.20%).

From the simple average analysis above one can see that it does make sense to go fixed for a longer period if possible whether you take a four year or a five year perspective, with the lowest simple average at 2.28 and 2.45 respectively, both by CIMB Bank. This has been a position we have taken for some time which remains valid today.

The only setback against locking into a longer term fixed rate mortgage is this – what if everyone was wrong and the global economy goes into another prolonged recessionary environment with rates languishing at current levels. One ends up paying this premium of 50 basis points (2.28 less 1.68) per annum over the next 4 years for nothing. Well as in all things in life, one needs to take a calculated risk. We think a lot depends on one’s outlook on interest as well the loan quantum involved. Obviously the costs of making a wrong bet can be huge for a $2M loan vs a $200,000 loan.

And remember in the example given we are assuming an ultra conservative pace of rate hike at only 2% increase over 5 years. If we take what has happened in the past one year as a guide, 3-month Sibor has spiked up from its low of 0.40 back in Sep 2014 to the current 1.14, an increase of approximately 0.70% in the span of 1 year, and the US Federal Funds rate has yet to even move.

In short, do not be seduced by lower fixed rates for 2-year, which also come with more frequent transactional costs for refinancing every 2 years instead of every 4 or 5 years. For smaller loans, even though the costs of making a wrong bet against rate increases is not as catastrophic, the need to have to pay higher transactional costs overall may outweigh any savings derived from taking a 2-year fixed rate.

At MortgageWise.sg, we seek to be your mortgage solutions partner and take pride in being able to give truly independent advice sometimes asking clients to re-price and stay with their existing bank if it doesn’t make sense for them to move. We may not get to do business with you the first time round, but we will try again. We strive to be your first choice mortgage partner when you buy your next Singapore condo. Meanwhile do sign up for our newsletter on our website and stay tuned to this blog as we bring you purposeful and proprietary news summary & insights.