During the middle of Circuit Breaker last year, I fully utilized the opportunity offered by a HDB loan to refinance into a bank loan. Given the $14,000 that I was guaranteed to save by switching to a bank loan, it was an easy decision to make. While making the switch, I had to tackle the classical dilemma of deciding between a floating or fixed interest rate for my home loan. That was the hard part because I realised that the right home mortgage is not just a case of finding the best interest rate across the various financial institutions, it is also about choosing whether you want the rate to be either fixed or floating. No wonder readers have written to me to understand how I tackled this problem. As the eventual decision chosen would have an impact on our financial health, careful consideration on our part is advised. Therefore, I have decided to share my thought process in this blog post.
Discuss with a professional
Like all home-owners, I was very confused initially as each camp had its own merits. However, after speaking with my home mortgage consultant and reviewing the loan packages from major banks (OCBC, UOB, DBS etc), I eventually settled for a fixed interest rate home loan. It was fixed for an unusually long period of 5 years at 1.5% p.a. but it suits my family’s needs, preferences and financial profile the best. Here are the factors that helped me decide between a floating or fixed interest rate for my home loan.
1. Savings over the near term
If cashflow is tight in the short term (i.e. 1-2 years), especially during an uncertain period such as now, then taking a floating interest rate home loan is almost always better. That is because fixed-rate home loans are usually priced slightly higher than floating-rate home loan as shown in Diagram 1.
The reason why fixed interest-rate is almost always priced at a premium compared to floating interest-rate loan is due to the certainty that it affords. That is the “price to pay” for having your monthly mortgage payments stay the same for each month during the period. Once the pre-determined fixed interest rate period lapses, the fixed rate will subsequently become a floating rate and it is probably time to call your mortgage advisor.
2. Savings over the long run
If you are not cash-strapped in the near term, you may want to take a longer view of the interest rate environment. If you think that interest rates are on the rise, fixed rate is more favourable because benchmark rates will likely change over time in response to market conditions. Put it another way, a falling interest rate environment means that selecting a floating interest rate package benefits you more. If you are unsure about interest rate movement, the easier option is to go with the market rates which is to accept a floating interest rate home mortgage.
Another school of thought is that if you think interest rate have come down so much such that there is limited room left to drop, you may wish to lock in at that rate. That means picking a fixed interest rate home loan package. When I refinanced in May 2020, the US Government mounted a massive expansionary monetary policy that caused interest rate to fall off the cliff to 0.25% as show in Diagram 2.
During that period, we also did not know if a vaccine would be successfully developed to resolve the pandemic and change the direction of interest rate. After an open and frank consultation with my mortgage broker, I signed up for the fixed interest rate home loan offered by DBS.
I realised that 1.5% is a level of interest rate that I was (and still am) very comfortable with and locking it in for 5 long years was the icing on the cake.
3. Lock-in period, penalties and subsidy claw back
You might be surprised to learn that the interest savings that you might have earned could be negated subsequently. Penalties for early partial repayment, cancellation fees and subsidies claw back are some of the common reasons that could potentially unwind all the hard work that you have done.
A fixed rate mortgage will almost certainly have a lock-in clause which could be a couple of years. It has also become increasingly common for floating interest rate loans to have a short lock-in period as well. If you choose to perform an early redemption, penalties ranging from 0.75% to 2% of the loan amount repaid earlier than permitted under the contract may kick in.
Financial institutions often dangle certain carrots to encourage consumers to sign up with them. They often come in the form of an upfront cash subsidy to help offset expenses for services that you will engage such as legal conveyancing and valuation. For instance, DBS offered me $2,000 cash to take up its home loan package. Via my mortgage consultant’s contacts, I eventually spent less than $2,000 for legal and valuation fees and got to pocket the small difference! However, if you apply to refinance or redeem your home loan within the claw-back period, bear in mind that this cash subsidy needs to be returned to the bank.
This also means that without an upfront subsidy, we cannot be refinancing our home loan every time we see a cheaper alternative. That is because we need to factor in the time required to break even on inevitable expenses aforementioned before we even start saving any money as a result of a lower rate.
1. What kind of Borrower Are You?
If you are a borrow who can stomach volatility and not worried at all about the scenario of runaway interest rates, a floating interest rate home loan might be the right fit for you. However, if you have low risk appetite and value stability, do opt for a fixed interest rate package. As we live in a time of unprecedented economic uncertainty, the predictability of a fixed interest rate home loan had just gone up intangibly by a few notches.
This persona describes Heartland Girl well, notwithstanding the fact that we have already accumulated sufficient cash balances in our bank to pay off our entire mortgage. For me, I am just happy to pay a little more for my wife to sleep more soundly at night. She is a key pillar in our optimised home loan repayment strategy afterall.
2. How Are You Paying Your Monthly Mortgage?
If you are paying your monthly mortgage repayments entirely in cash and not via CPF, a fixed mortgage rate home loan is recommended because it provides financial certainty on how much you are paying each month. You can calculate mortgage payment with confidence, properly budget your monthly expenses which should lead to better financial management for the household.
3. Refinancing Is Not Guaranteed
Regardless of whether you have chosen a fixed or floating interest rate home loan, you will realise that after the first few years, interest rates may be revised upwards, ceteris paribus. That is because the promotion rates to entice you to sign up would have already ended. If you do not bother to refinance, you will commence paying heftier interest on your home loan. However, I like to caution that success in securing your initial home loan does not mean that your subsequent home loans will be a breeze.
In fact, refinancing is never guaranteed. Every refinancing is subject to approval based on the latest financing rules which could change over time. It is not too long ago that Total Debt Servicing Ratio and lowering of Loan to Value ratios were introduced by Singapore government as cooling measures to contain a heated residential property market. Moreover, the bank will assess and evaluate the borrower’s financial status at time of refinancing. Given how our rice bowls are becoming increasingly unstable, it is really not wise to bank on refinancing all the time.
Floating or Fixed Interest Rate?
I feel that one need not worry too much about making a “wrong” decision with regards to deciding between a floating or fixed interest rate for your home loan. In Heartland Boy’s opinion, what is more criminal is not refinancing or repricing after the lock-in period when you are eligible to. That would be leaving money on the table, especially during a time when fixed interest rates are as low as 1.25% (fixed for 2 years) while floating interest rate are as at 1.255% (3M SIBOR +0.85%) as at 17 Jan 2021.
If you are interested to refinance your home loan, happy to link you up with the mortgage broker/consultant who assisted me on this classical dilemma.