When it comes to forecasting interest rates, even the US Fed armed with their repertoire of statistics and market indicators can err (they predicted in Dec there will be 4 rounds of increases but changed that stance recently), what about the rest of us?
Here at MortgageWise.sg though we maintain our view that there will be two round of increases this year and talk of rate hike will resume as economic activities start to pick up again with the return of spring this quarter, no one can predict the future with 100% accuracy. What if one has a substantial outstanding mortgage and is still undecided about his outlook on interest rate movement?
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For loan sizes say above $1m, the costs of making a wrong bet is high and we have always advocated going fixed for longer period like minimum 4 years to ride out the entire interest rate up cycle, even if one has to pay a premium in terms of slightly higher fixed rates compared to 2-year fixed (the lowest). However many banks are not offering legal subsidy or cash rebate in full for fixed rate packages.
One clever strategy that a homeowner could employ in such a scenario is the concept of a combo loan. As the name implies, it’s basically a combination of fixed and floating rate package. Not all banks offer that but at this moment DBS offers what it calls “Managed Mortgage” which is in essence a combo loan. How it works is when one refinances the loan, the new bank takes over the entire loan for example $1m but breaks it into 2 parts – Housing Loan 1 of $500,000 on fixed rate package, and Housing Loan 2 of $500,000 on one of the existing floating rate package. By doing so effectively one could then get cash rebate of $1500 on housing loan 2 as DBS offers cash rebate for its floating rate packages only subject to a minimum loan size of $500,000.
How does such a combo loan work for the benefit of homeowners? First let me re-iterate the homeowner here is one who is still undecided which way interest will move, or he thinks the climb will be so slow that it amounts to 2 steps forward but 3 steps back. If interest does stay down for a protracted period, he stands to benefit from the floating portion of the loan, plus not having to pay a premium on fixed rate for the entire loan but only half. What happens if interest should rise steadily over time as expected. In such a scenario by having half the loan on fixed, the increase in interests will also be halved on a combo loan. And in the worst case scenario where interests shoot up too quickly, the last resort would be to pay down on the floating portion which has no lock-in. In this regard, combo loan works especially well for those with substantial cash or CPF funds and are prepared to deleverage the moment interest goes above what they would earn with their CPF money at 2.5% p.a. interest. We know there are many clients who chose to take a much bigger mortgage over the last few years when interest stays in the doldrums.
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Perhaps then one way is to decide on the portion of floating is to match that to one’s liquid cash and/or CPF funds for partial redemption when the need arises. And that’s exactly another point I like to highlight on use of combo loan – the split between fixed and floating need not be 50:50 which many in the market may not be aware of. For example, to take advantage of cash rebate given only for floating rate portion, make that $500,000 and the rest fixed. However be aware of the risk involved if a big portion of the loan is left to floating; one must be confident of paying down should interest rises too quickly.
Besides DBS home loans, there are at least two other banks which can structure such a combo loan. Do speak to our team of experienced mortgage consultants before you refinance home loan. Make a difference to the way you plan your mortgage by consulting with a professional whose insights, experience and independent advice you could benenfit from, instead of going directly to the banks for their “standalone” views.
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.