Mortgage advisory is not rocket science. There are really just two choices: when interest rates go up choose fixed rate home loan, and when interest rates come down, switch to floating rate. But what do you do when it goes flat like now?
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To answer that, we must always go back to the interest rate cycle. Few mortgage blogs discuss the interest rate cycle in details. Here at MortgageWise, the cycle forms the premise of all our recommendations as we track Fed action and macro events. It is our belief that better mortgage decisions – fixed or floating rate home loan, are made not in isolation but in respect of where we are in the cycle.
With that let’s take a look at the interest rate cycle – showing the correlation between US Fed funds rate and 3-month SIBOR.
3-month SIBOR has reached the current base level at around 0.40 in Aug 2020 and have hovered at that level since. 1-month SIBOR (not shown here) has also stabilized at 0.25 or a gap of around 15 basis points to the 3-month SIBOR. We are somewhat back to the same levels in the post financial crisis period of between 2009 to 2014. The big question now is how do you project the interest rate trajectory from this point. Is it going to gradually rise up or go plateau for long periods just like before?
The answer to that question hinges largely on inflation in the US which will trigger Fed tightening action at some point. And that point is not anytime soon yet. That’s a whole separate discussion about QE (quantitative easing) and hyper-inflation in another article in this blog. In this article, I like to discuss more broadly the strategy you should adopt at different stages of the interest rate cycle and we will take stock of events in the most recent 10 years.
(This may be a lengthy article, but I assure you it will be a worthwhile read. Those who seek to always save on interest costs all through the interest rate cycle should take note of the different strategies at different phases of the cycle. Better yet, work with a trusted broker with a proven track record since 2014.)
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The Plateau (2009 to 2015)
For long periods of almost 6 years in Singapore, interest rates remained subdued at 0.40%. Nobody was keen in the higher fixed rates as prevailing interest rate hovered in 1% range-bound.
MortgageWise started operations in 2014. Had we been around much earlier, I think our take would have been: stay on floating rate home loan when there’s no indication of any impending Fed rate hike, the lower floating rate but stay nimble as much as possible.
The Rise (2016 to 2018)
In fact, there was a false start for interest rates in Singapore when oil price crashed from its high of USD150 per barrel in Oct 2014 and SIBOR shot up as a result. The market clamoured for fixed rate for fear of runaway interest only to see SIBOR come down in 2016. This was primarily due to a slowdown in economic activities in Singapore. Banks were flushed with liquidity and unable to lend out even as they battled fallout from a beleaguered oil & gas sector.
As a result, those who opted for higher fixed rates felt short-changed at the end of their 2-year lock-in period, or worst for some who signed for 5-year fixed at above 2.20%. Rates did not shoot up that high it turned out. I recalled we have DBS offering 2-year fixed at 1.40% by 2016 with a fallen SIBOR. In fact, those who signed floating rates on SIBOR would have enjoyed the slide down as their 1-month SIBOR interest rate got reset every month.
The real ascent started with the historical first rate hike in a decade by US Fed in December of 2015. Hence, we marked “The Rise” phase of interest rates from 2016 (the black line for Fed funds rate). This was to be followed by a total of eight more hikes over the span of the next three years to bring the fed funds rate near 2.50%.
This was the only time when those who opted for fixed rates turn out to be winners. Those who opted for floating rates on BOARD or even FHR saw their interest rates revised up multiple times in one year especially in 2018. Still, remember not all who were on fixed rate become winners because some signed for 5-year fixed rate at 2% (rates started coming down after 3 years). And there were others who simply repriced for another round of even higher fixed rates without first looking at the interest rate cycle.
What we also learnt in this phase of the cycle – a 3-year fixed rate is often enough to hedge against rising rates if you get your timing right. Those who go longer than 3-year run the risks of “over-hedging” – get stuck with a high fixed rate and watched helplessly when prevailing rates come crashing down. If you look back in history all the way from 1990, almost all the interest rate ascent peaked out in three short years – the Fed cannot go on hiking rates indefinitely without a correction.
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The Crash (2019 to 2020)
At MortgageWise, we started looking at the chart more closely and realized there’s simply no way Fed can continue in its pace of another 9 hikes over the next 3 years. Doing that would amount to the magnitude in the last accent from 2004-2006 where Fed funds peaked at over 5% (and 3-month SIBOR went to 3.56%). Stock market would have crashed multiple times before that happens.
It is at this juncture, at the start of 2019, that we switched to recommending floating rate home loans and only those on SIBOR where we believe the market is a better peg than individual banks’ pegs going forward. No one could foretell a pandemic the following year. We were simply expecting rates to go plateau again at some point after Fed made policy U-turn and cut rates thrice in 2019.
When rates go south, best thing to do is to switch to floating rate on SIBOR. And there’s loads of benefit to do that quickly before banks would adjust their spreads up to match a falling SIBOR. Clients who followed our advice at the start of 2019 are having the last laugh now as two years later their interest rates remained at 0.50-0.75% (final rate). In fact, our CRM is now prompting them for a review after two years as promised and no prize in guessing what’s our recommendation to them now: “Do Nothing! For that matter, don’t even reprice.”
The Plateau Again? (2021 to Unknown)
We have entered another plateau for interest rates in the last 6 months since Aug 2020. Will the 6 months turn into another 6 long years of interest rate trough? Despite all the debate (and confusion) that rages on, I think the pandemic has reinforced the likelihood of that happening.
In his most recent comment in a speech to the Economic Club of New York, Fed Chair Jerome Powell painted a bleak picture of US labour market and said that “US is long way from where it needs to be in terms of employment”. Fed Chair talked about a “patiently accommodative monetary policy that embraces the lessons of the past” in that speech.
We have come a full circle – back to near 0%. Even though fixed rates had crashed to all-time historical low of 1.15-1.20%, our recommendation hasn’t changed since 2019. We are still very much for the benefit of SIBOR floating rate home loans at almost 1%. Why?
Because if you still don’t go floating now at near 1%, then when will you ever go floating? The gap between the lowest floating and fixed rate now is about 15 basis points or 0.15%, which translates into $1,000 savings in interest per year, or $2,000 over 2 years, for a typical loan $700,000.
If you opt for 2-year fixed rate now at 1.20%, think what happens when your lock-in expires in 2023? If interest indeed starts rising by then, as you have feared, guess what – your fixed rate just expired at the wrong time! And you would have paid at least $2,000 extra (or even more for bigger loans) in interests in the last two years for nothing.
And the worst part – you will continue to choose fixed over floating in 2023 as the world would have gotten back to a much stronger footing post-covid. Which means you will continue to overpay $2,000 or more every 2-year lock-in period until we get to the point where Fed is clearly on a path of sustained rate hikes, and that may come 6 years later if history repeats itself.
Still unsure what to do? Speak to our team of mortgage consultants who meet regularly to dissect the market, watch the interest rate cycle, and uncover what’s best out there for clients.
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