Fixed Rate Or Floating Rate?

The first month of the new year has seen a flurry of activities as banks in Singapore scurry to adjust, re-adjust, tweak and re-tweak new packages for fixed rate home loans as the market scrambled to fix their mortgage rates.

Indeed you can expect the scare out there if sibor is to continue rising over the next few quarters the way it did in December, with 3-month sibor rising 40% from 0.45 to 0.65 currently, albeit it has stabilized a little. Most analysts predict that 3-month sibor will reach 1% by end of 2015. We think that it will go even higher. Follow our blog.

If it hits 1% p.a. by Dec this year, most borrowers in Singapore would have to pay close to 2.25 %p.a. on their mortgage when their lock-in expires and typically their rates get adjusted upwards to a 1.25% spread from Year 4 onwards. Hence, refinancing is going to be theme going forward considering 80% of the home loan market is on floating rate sibor over the last 4-5 years.

The most common question we get now is should we fix the rate now or just hold back for a while longer?

To that question I always answered with a question. What is your outlook on interest rate going forward over the next few years? You need to decide on that first and take a position before you will know which home loan to choose.

Generally the consensus is that with recovery in US market, rates are going to rise. The not-so-clear issue is how fast, or how much will it rise to and by when? For that one needs to gaze into the crystal ball for answers.

At MortgageWise.sg, we say do not bother to even predict. At this moment, we are simply advising all our clients to go lock-in fixed rates as quickly as you can while it is still below 2% p.a., which though it has risen slightly from last year’s all-time low (around 1.38-1.42% p.a.), it is still at the lower end of the range historically. Currently fixed rates are hovering in the 1.5 to 1.88% pa. range depending on whether it’s a 2 year or 3 year fixed rate home loan.

It’s no-brainer for us. Why so? Simply look at the lowest floating rate package out there at the moment – DBS home loan on FHR (Fixed Deposit HomeLoan Rate) +0.85% (Yr 1) and +0.95% (Yr 2) which comes to 1.25% p.a. in the 1^st year, and 1.35% in the 2^nd year. If you take a simple average that would be 1.3% p.a. over 2 years. What is the difference between 1.3% and the lowest fixed rate of simple average 1.4% currently offered by Bank of China? Insignificant. Let’s look at one example of a typical loan to illustrate my point :

Outstanding Loan                            = $700,000
Remaining Tenure                           = 27 years
At 1.3% monthly instalment          = $2,563
At 1.4% monthly instalment          = $2,596
Difference per month                      = $33
Difference over 24 month              = $792

I am sure $800 is not a lot of difference to a lot of people. Which is exactly our point – why bother to save just $800 with floating rate, while the risk of getting your bet wrong and should sibor shoot up to over 2% in the next 2 years your savings would be many multiples of $800! Just go fixed and lock in your rates today while it is at 1.4-1.6% range. It does not make a lot of difference at all to your monthly repayment. In fact we recommend our clients to lock-in for 3 years even if it is at a higher rate – Maybank’s simple average of 1.75% over 3 years fixed:

Outstanding Loan                               = $700,000
Remaining Tenure                              = 27 years

DBS’s current floating rate package is at FHR+1.2 in the 3^rdyear (or 1.6%), hence simple average over 3 years = 1.40% p.a.
At 1.40% monthly instalment          = $2,596
At 1.75% monthly instalment          = $2,713
Difference per month                        = $117
Difference over 36 months               = $4,212

What this simply means is that by locking down a slightly higher fixed rate at simple average of 1.75%, you are taking a bet of $4212 that if rates move up beyond 1.75% + 0.35% or 2.1%, you would have saved on interest by moving to fixed rate now. 35 basis points is the premium you pay for fixed rate now vs the lowest floating rate average, ie. 1.75-1.40, hence also your breakeven.

So ask yourself how likely will rates move up to 2.1% and beyond and how soon? Already we are not very far away from this number.

Finally for those with substantial loans like above $1M, we bet that you will likely save even more if you lock-in a fixed rate home loan of 1.88% for up to 4 years by Stanchart, the only bank offering fixed rate package beyond 3 years right now. However you have to act fast, as this promotion ends 28 Jan 2015!

(Note : In this article we use simple average to calculate average interest over 2 or 3 years and we ignore the effect of interest amortization where you actually pay slightly more interest in the 1^st year compared to 2^nd year and so on, as this would make the calculations too complex for the purpose of this article.)