Fixed Or Floating Rate Mortgage?

Last week following the surprise devaluation of the Chinese yuan and ensuing strengthening in USD, the interbank rates have started to move again after stabilizing at the prevailing levels for several months.  The 3-month Sibor has risen from 0.82 (as at end-July) to 0.93 in the span of two weeks.

With interest rate on the rise, homeowners in Singapore get jittery with higher monthly repayments and wonder is it more beneficial to go for fixed rate or floating rate mortgages when their existing loans come up for renewal.

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It is certainly not an easy decision as no one knows exactly how the rates would move.  However there are some simple steps one can take which might help in the decision process.

Step 1 : Determine what is the premium to pay for fixed rate

At the start of the year when fixed rates are range-bound in the 1.3 to 1.5% p.a. it was a no-brainer.  When floating rates also hovered in the same region most would just go for fixed rates of 2 to 3 years for that peace of mind.

In this blog we have earlier predicted fixed rates to go above 2% p.a. latest by June which did not happen largely because MAS intervened in a surprise move back in April with easing of Sing dollar and the subsequent stabilizing of oil prices.  Still we are not very far off in our prediction either as fixed rates have hovered near 2% since June with most of the foreign banks (with higher costs of funds) going above 2% and local banks holding it at 1.88 to 2% p.a.  Prevailing floating rates (when we look at average over 3 years) have also stabilized at the 1.5% range over the last few months.

This translates into an additional spread of around 0.40% that one has to pay in order to lock in fixed rates when compared to floating.  Is this additional “premium” justified or is it worth paying?  That would depend of course on your loan size and how much savings is that over 3 years?

Based on a typical loan size of say $700,000 over 25-year tenure, the difference in monthly repayment is $2800 vs $2960 for interest rate of 1.5% vs 1.98% respectively.  In terms of cash flow, that is a monthly savings of $160 or a total savings of $5,760 over a 3-year period.

Obviously this savings is fairly substantial especially for bigger loans more than $700,000, but remember that is provided the floating rate peg (usually sibor or board rate) does not move within 3 years; which brings us to the next step.

Step 2 : Take a view on the pace of interest rate hike

This is the difficult step as it requires gazing into one’s crystal ball.  Interest rate is set to rise but just how fast will it spike up?  The general view is that even after US Federal Reserve’s 1st liftoff of the federal funds rate in almost a decade, the rate of subsequent rounds of increases will be gradual so as not to jeopardize the fragile recovery process of an economy that is still reeling from effects of the Great Recession.

In our humble view that could still mean two rounds of increases in one year and with each typical increase to be 25 basis points as shown historically.  Which also means if the premium to pay to lock down fixed rates over prevailing floating rates is only 0.40% as explained in step 1 above, it will be wiped out in just one year.  In other words, it does make a lot of sense to go fixed rather than floating rates.

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In fact we recommend going fixed for at least 3 years for maximum savings so that you enjoy 2 full years of lower fixed rates after floating rate levels up with your fixed rate within a year.  And with fixed rates still historically low when you look over a 3-decade period, we dare say it is justified as well to pay up to 2.45% p.a. and go for the longest fixed rate package in Singapore of 5 years by one particular foreign bank.

With sibor rising in recent weeks, we do think some banks will start to move up their fixed rates as early as end of this month, so if one plans to do so and take advantage of the small premium today at only 0.40% (narrowing now with rising sibor) to go fixed, one should delay no further.

On the other hand we do know there are those who take the contrarian view that the world is in such a state of chaos and imbalance as all the excesses from the past decade’s QE have yet to be sorted out – there is likely another global recession lurking round the corner or another bubble bursting as early as in the 2nd half of 2015!  Hence it is better to go with floating rate and only lock in higher fixed rate if need be at a later time, ie. adopt a wait-and-see approach.  After all no one knows for sure.  The current slowdown in the world’s 2nd biggest economy of China does warrant a deeper concern than Greece crashing out of Eurozone.  All eyes will be on what the Chinese government does next and if it will be successful in pump-priming its economy back to the growth path and doing it fast enough.

Having said so much, there is one floating rate home loan in the market that might prove to be the right choice running contrary to our views so far.  Read our next article to understand why in this particular instance, floating rate might help homeowners save more than fixed rate especially for bigger loans.

Step 3 : What is the likelihood of one selling away the property?

A last consideration is whether one will be selling the property within the fixed rate period as doing so will attract a prepayment penalty usually at 1.5% on the loan amount redeemed.  For this reason we have always suggested that one should go fixed for an owner-occupied property more so than an investment property.  This is because no matter what happens to the economy or property market, there is always a need for a roof over one’s head and most people do not sell the home where they live in purely for profit reasons.  There will be a lot of disruptions to living arrangements and finding the next home is not an easy task too.  Compare that to an investment property where the maxim is always to buy low and sell high and try to minimize carrying costs while waiting by looking for maximum yield and lowest cost of funds.  One never knows when the buyer who makes irresistible offer will show up at the door.

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Having said that, there is one bank though that waives off a substantial part of this prepayment penalty even for a fixed rate home loan should the redemption be due to a sale of property during the lock-in period.  This allows one then to take up a fixed rate mortgage even for an investment property.

At MortgageWise, 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 in Singapore when you buy your next property. 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.

 

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About Darren Goh

Darren Goh is the Executive Director of MortgageWise.sg, a thought leader in the Singapore mortgage industry, with frequent interviews and quotes by the press - Business Times, Straits Times, Zaobao and EdgeProperty for his views on the latest mortgage trends. He is an avid property investor with careers in banking & real estate before becoming an entrepreneur.
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