Should one choose a fixed or variable rate mortgage package when taking a new or refinancing home loan? Nine out of 10 people are asking that question today, and finding a suitable answer has become more difficult amidst market volatility.

Before I answer that question let me just state as a fact that when interest rises, just as all ships go higher when the tide comes in, eventually everyone pays higher interest.  The crux is how does one manage this rise in interest over time to pay the least of any increases.  Naturally the tendency is to go lock down fixed rate especially when the premium of fixed over floating is not that high (as you can see from our rates chart below). In reality is it really that simple?

Let us examine this on a typical refinancing case of $600,000 outstanding loan using the best rate for both fixed and variable at the moment.  For the latter, instead of the traditional SIBOR loans, we will use the popular Deposit Mortgage Rate (DMR) packages currently offered by only two banks – DBS home loans with its FHR18 and OCBC home loans with its 36FDMR.  DMR is a relatively new mortgage loan peg where one’s mortgage interest is derived by adding a contracted spread on top of a published deposit rate of the bank. In the case of OCBC’s 36FDMR loan, the interest is pegged to its 36-month fixed deposit (for amounts S$5,000 to $20,000) currently at 0.65% p.a. We will use OCBC in this example as the bank also offers an attractive cash rebate of $1,500 for refinancing loans of this size.

Current Outstanding Loan                   = $600,000
Remaining Tenure                               = 22 years

Current Interest (in 4^thyear)                = 3M SIBOR (1.25) + 1.25 = 2.50% p.a.

It is clear that given the generally-accepted view of a slow pace of rate hikes especially more so on a DMR home loan, for loan sizes of $600,000 over a 3-year period, the savings from going on a 2-year fixed rate is wiped out by the transaction costs of refinancing given the need to refinance a 2^nd time after 2 short years (when fixed rate ends the interest always revert to a much higher floating).  And note that here we assume that the homeowner stays put with SBI and simply reprice with the bank on their prevailing 2-year fixed rate package in 2018 which we assume is 2.80% and it may not be the lowest in market.  If the homeowner chooses to refinance out instead to another bank, the legal subsidy of $1,000 given earlier will be clawed back in full which will further increase his total costs beyond $40,000 (minimum clawback period for legal subsidy is standardized as 3 years for almost all banks in Singapore).

Some may wonder why we look at over 3 years?  Typically most home loan packages in Singapore be it SIBOR-based or DMR-based ends their promotional spreads after 3 years and revert to a higher spread from year 4 onwards.  That is also the point when most homeowners will look at refinancing options.  In this case OCBC’s 36FDMR package charges a spread of +1.23 for the first 3 years of the loan and it goes up to +1.70 from year 4 onwards.

The only two caveats we need to give here is when interest creeps up much faster than what the market anticipates, or when the loan size involved is much bigger like over $1m where the transaction costs of refinancing home loan as a percentage of total costs goes down and justifies going on fixed rate.  Still we will advocate fixing over a longer term of 3-4 years so as to spread the transaction costs over a longer period.

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.