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Should We Lock In 5-Year Fixed Rate Home Loan?

Just this week CIMB became the latest bank to fire the next salvo in the battle for fixed rate home loans in Singapore – a 3-year fixed rate at 1.88% p.a., a 4-year fixed rate at simple average of 2% p.a.(1.65%, 1.85%, 2.15%, 2.35%) and most impressively the longest ever in the market a 5-year fixed rate at 2.28% p.a. for private properties. The rates for HDB are slightly higher across the board up to 2.30% p.a. for 5-year fixed.

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The market has finally woken up to the demand for fixed rates with the impending rate hike in US. CIMB has been wise not to ignore this changing need and indeed kudos to them for responding swiftly and decisively with the most aggressive fixed rate package to give the market another interesting option. Until now, most banks are reluctant to offer more than 2-year fixed rates, which if I may surmise a guess, due to the lower margins arising from having to lock in longer term funds at a higher rate from the interbank market.

The question now we get asked is should we go lock ourselves up to 5 years and pay a slightly higher rate than what is the prevailing rate now, just for that peace of mind that comes with a fixed monthly instalment? Let’s examine this question in this article.

First understand that the first pre-requisite for locking down fixed rates is that you do not envisage yourself selling the property to be financed in the next 5 years, as fixed rates always come with a commitment period of the same length where you will be slapped with a prepayment penalty of 1.5% of the amount paid down during this 5-year lock-in period. Purchasers of a new HDB or Executive Condo property will not be too concerned with that as that ties in perfectly with the minimum occupation period of 5 years.

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Most of us will not want to sell the house where you are currently staying unless you have a reason for moving, for example to get ready to enrol your child in a specific school few years ahead of time, etc. It follows then that, unless you foresee a need to sell in the next 5 years, the first rule of thumb is that you should go into a fixed rate mortgage for your owner-occupied property. This is especially true for those with more than 2 properties (which you may also want to look at locking down your interest costs for the property with the biggest outstanding loan). Five years is not a very short time and you never know when you might get an exceptionally good offer for your investment property and you might just want to cash out and take profit and redeploy your funds.

Now we are ready to look at the virtue of locking in fixed rates over prevailing market rates. The case for fixed rates will not be difficult to argue when you look at the current floating rates hovering in the range of 1.45% p.a. for the initial years. When you lock in a 3-year fixed rate home loan (currently in the range of 1.75%-1.88% p.a.) you are essentially paying just 30-40 basis points higher which will not translate to much difference in terms of monthly repayment. For example, without going into loan amortization but taking simple application of 40 basis points or 0.4% p.a., every $100,000 outstanding loan will increase by $400 per year or $33 per month (actual will be much lower at around $19 more per month using 25years and difference between 1.88% & 1.48%). Using a typical loan of $700,000, you are talking about a difference of about $200 increase in your monthly instalment which you will agree is insignificant when compared to interest rates rising above 2.5% p.a. eventually.

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This is the reason why at MortgageWise, we have been asking our clients to switch to 3-year fixed rate loan since October 2014 unless they have plans to sell their property within 3 years or they see a risk of being unable to refinance after 3 years when rates revert to higher levels. Our position is that as long as fixed rates stay below 2% p.a., or at half the historical average of 4% p.a. for Singapore’s 3-month sibor rate over the last 20 years, one will not err going into fixed rates.

The harder decision now is to choose between a 3-year fixed rate at average 1.88% p.a. or a higher rate above 2% p.a. for longer lock-in periods. Until another bank comes along with a 4-year or longer fixed rate home loan, that will be CIMB Bank. If this is your owner-occupied property, or one with the biggest outstanding loan, we think it makes a lot of sense to switch over to the latter – a 4-year fixed rate at simple average of 2% p.a. We even recommend the 5-year fixed at 2.28% p.a. !

We will only know on hindsight if this is the smartest move you can make at the start of 2015, when prevailing interest rates though rising are still at historically low levels unseen for a decade. We have already established the case for 3-year fixed rate earlier. And at simple average 2% p.a., this will be a no-brainer at about another 20 basis points more or 0.6% p.a. over prevailing floating rates, which again on a typical $700,000 loan is around $300 (overstated) more per month.

The only way to evaluate at this point is to postulate what would be the prevailing 3-month sibor and the corresponding 3-year fixed rate promo in the next few years. This is what we think would happen on a very conservative basis (assuming US Fed will err on the side of caution and go on only 25 basis points increase per year)

 3-Mth Sibor3-Mth Sibor+0.803-Yr Fixed Rate
2015 End1.001.802.20
2016 End1.252.052.50
2017 End1.502.302.70
2018 End1.752.553.00
2019 End2.002.803.20

In the scenario above, if you have locked in a 3-yr fixed rate today at 1.88% p.a., you would likely refinance to another fixed rate loan at the end of 2017 at 2.70% p.a. which will translate to an average of 2.20% p.a. (1.88×3+2.70×2 over 5 years). This would be quite comparable to CIMB’s 5-year fixed rate of 2.28% p.a. today. By the same token, the 4-year fixed rate will be 2.08% which makes CIMB’s 4-year fixed rate today at simple average of 2% attractive!

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This is the only way we can make some kind of calculated assessment on CIMB’s fixed rate loan. However bear in mind at, we believe the rate of interest rate increase should be more acute than the conservative example above. We believe when the recovery gains further traction in the US, and if Euro and China manage to turn the corners as well, there will be a momentum as the general feel-good factor and confidence feeds on itself.

In conclusion we believe the potential benefit of locking into CIMB’s 4-year and 5-year fixed rate package today far outweighs the risk.

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