That is the number 1 question on people’s mind and in 9 out of 10 cases the first thing that clients ask for when they approach us. But is fixed rate really the best solution over the long term? Let us take a closer look.
I would answer a resounding yes to that question only if one is planning to sell the property the moment the fixed term ends. Other than the holding period, there might be other considerations homeowners often overlook due to fear of runaway interest, namely the type of property, outlook on pace of interest hikes, size of the loan, transaction costs involved and the ability to do repayment after the fixed term ends.
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First on the type of property, if this is an owner-occupied property and there are no plans of selling, there will be no issue with lock-in period that comes with a fixed rate home loan typically, as opposed to investment property where most investors prefer to retain the flexibility of selling at any point when the right offer comes along. Another added advantage of not going fixed on investment property is that MAS gives a grace period for TDSR (Total Debt Servicing Ratio) exemption until 30 Jun 2017 for those deemed over-leveraged; once the fixed term ends those who are over 60% TDSR would be unable to refinance after this date. It is imperative for this small group of investors to find a mortgage peg that is more stable and less volatile in the long term, rather than going for fixed rate. You can see how the type of property plays a part in the decision to go fixed or floating. One final perspective on this – it makes sense to go fixed on owner-occupied home as one literally service the interest costs from his hard-earned income as opposed to an investment property where there is rental cash flow to defray costs of rising monthly mortgage repayments, as long as the interest component can be covered.
I have often read with amazement how some mortgage consultants tout “just go fixed rate” without any considerations to factors like pace of hikes, size of loan and transaction costs involved. Let me now discuss them collectively using the graph below. Here let us take the generally-accepted view that the pace of rate hike will be gradual (benchmark 3-month SIBOR to rise by 0.50% p.a.) over the next 3 years and as the global economic recovery gathers pace thereafters leading to more pressure on price and hence inflation, the pace doubles to that in a normal interest upswing cycle (1% p.a.). Let us further assume that if one is on a deposit mortgage rate (there are two in the market now – OCBC home loans on 36FDMR & DBS home loans on FHR18 and we will use the latter in this illustration) it will rise by approximately half that of SIBOR at 0.20% during each round of increase and the bank will hike this peg twice in 2016 due to rising NPLs (non-performing loans) and slow to one round in 2017-2018 but picks up pace again in 2019-2020.
Given the projected pace of rate hikes over the next 5 years, contrary to what most believe, adopting a 2-year fixed-and-renew strategy will lead to higher interest costs over a 4-year period as shown. The initial savings (orange area) attained in the first two years by locking down 2-year fixed rate today at 1.99% p.a. gets eroded by the much higher fixed rate during renewal in early 2018 at 3.38% p.a. In fact when the pace of rate hikes picks up in 2019 the savings on fixed gets eroded even more if we extrapolate by two more years until 2021.
What would change the conclusion here is of course should US Fed reverse its rate hike policy as the global economy tanks in 2016 and interest does not come up at all in Singapore. However even if that is to happen, going on 2-year fixed will still lead to more transaction costs with the need to refinance after 2 short years as compared to staying on deposit mortgage peg where home loan refinancing may or may not be required after 3 years depending on which package one takes up with. In other words, should SIBOR (purple line) stays down, FHR18 (black line) would by definition stays even lower. How about the scenario where the pace of rate hikes go so quickly and catches everyone by surprise? I put to you that belongs to a minority view given the state of global economy at the moment. Incidentally if the purple line were to go much steeper than what you see here, I would argue that might be the best point to go fixed and for the longest fixed term available.
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The typical refinancing costs comprise of 2 components – legal fees in the range of $2200-2500 and valuation fees in the range of $500-600, for properties with valuation below $3M. The total out-of-pocket expenses incurred of at least $2700 might wipeout any savings (orange area) on a 2-year fixed rate depending on what is the size of the loan involved. For this reason we always ask clients with outstanding loan of less than $500,000 to think again when they ask for fixed rate. We need to do the calculations for them before we can advise further but we are usually not wrong.
Finally there is a small group of homeowners with the capacity to pay off (using CPF or cash) a substantial portion of or even the entire mortgage should interest rises any higher than CPF OA rate (currently 2.5% p.a.). For this group, managing one’s cost of funds takes on more perspective and fixed rate may or may not be the best option and they should seek further advice from a professional mortgage consultant.
In conclusion there are at least 6 considerations to look at before one should decide to go fixed or floating but on a less volatile deposit mortgage peg for example. It may not be as straight-forward as it seems. And do not forget, the legal subsidy (or cash rebate nowadays) for refinancing that comes with 2-year fixed rate may be clawed back from you just when you thought you could refinance out or even reprice in the third year after the fixed term ends. Read the fine print.
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 home loan Singapore.