Why fixed rates are still preferred over floating rates?
By Feily Sofian
/ The Edge Property |
Mortgage fixed rates have risen from an average of 1.7% per annum in January to 2.2% in May, before stabilising at 2% in June. The rates apply to loans with a two- to three-year lock-in period, based on data compiled by mortgage consultancy house iCompareLoan.com.
Meanwhile, floating rates now stand at 1.9% after the three-month Singapore interbank offered rate (Sibor 3M) spiked to 1.13% on Sept 14. Floating rates are commonly computed as the prevailing Sibor 3M plus a spread of 0.8%. Is it still favourable for borrowers to switch from floating to fixed rates, given that the latter are no longer cheap to service?
Intuitively, fixed rates seem to be a favourable option at this juncture as they are priced at a premium of just 0.1% to 0.2% over floating rates. The premium represents the price borrowers must pay for the certainty they enjoy by locking in a fixed interest rate over two or three years. In addition, floating rates are bound for more upside along with US interest rates and Sibor 3M, which would likely offset the current fixed rate premium.
The more relevant question would be how much savings a borrower could expect by switching to fixed rates, rather than whether fixed rates are more favourable than floating rates. MortgageWise.sg, a boutique mortgage brokerage firm, says it would hinge on how fast Sibor 3M would rise, which in turn determines the floating rates. Computation shows that borrowers could still pocket some interest savings even if Sibor 3M were to rise at a gradual pace, but they might have to lock in the fixed rates for three years.
iCompareLoan.com compared the accumulated interest over three years under the fixed and floating loan packages, assuming a loan amount of $500,000 over 20 years from Sept 14. For the floating rate package, iCompareLoan.com simulated Sibor 3M of 1.57%(up 0.5 percentage point from 1.07% on Sept 13) plus a spread of 0.8%. Although Sibor would fluctuate, the computation uses the same rate for three years. Based on this, the floating rate package would yield the accumulated interest of $33,534 at the end of the third year.
The mortgage consultancy house then simulated the same loan under a fixed rate package with fixed interest rates of 1.68% for the first two years and 2.28% in the third year (based on an actual package that is currently being offered). It resulted in an accumulated interest and exit costs of $27,323 at the end of the third year (see table). The fixed rate loan package saved the borrower about $6,000 ($33,534 less $27,323) of interest over three years. Exit costs include a lock-in penalty as well as legal, fire insurance and valuation clawbacks, where applicable.
What if Sibor 3M were to rise at a more conservative pace to below the 1.57% simulated earlier? UOB forecast Sibor 3M to be 1.15% in 4Q2015, 1.22% in 1Q2016 and 1.27% in 2Q2016.
The Edge Property computed the accumulated interest rate for three years from September based on UOB forecast and assuming Sibor 3M stays at 1.27% from 2Q2016. It resulted in an accumulated interest of $28,918 over three years, which still yields a saving of $1,595 ($28,918 less $27,323) to those who opt for a fixed rate package. It may not amount to much, but fixed rates offer more certainties to the borrower. Ultimately, the resultant savings would depend on the loan size.
The decision to switch from floating to fixed rates was much simpler earlier this year, in times when interest rate hike was as certain as death and taxes. Back in January, it made absolute sense for borrowers to lock in the fixed rate of 1.7% for two to three years. Then, Sibor 3M was projected to rise beyond 1%, which is happening now, resulting in a corresponding floating rate of at least 1.8% (1% Sibor 3M + 0.8% spread).
Table
How fast is Sibor expected to rise?
UOB economist Francis Tan says the recent spike in both Sibor and swap offer rate (SOR) was due to the bullish expectation on the US dollar against the Singapore dollar. “Emerging market fragility has sown fear of capital outflow and the US dollar has become a hedge for investors,” he explains. UOB expects the strength of the US dollar to moderate. In view of this, Sibor 3M is forecast to trend up at a more gradual pace.
From a historical point of view, the spread between Sibor and SOR has also widened too far and too fast, according to Tan. “The trend is not sustainable and should decline quite quickly as Sibor trends higher towards our forecast of 1.25% by end-September and as SOR moves in the opposite direction,” he adds. UOB then forecast Sibor 3M to ease to 1.15% in 4Q2015.
Vishnu Varathan, senior economist at Mizuho Bank, says: “The nature of the sudden surge in SOR over the last few weeks since late July tells us that some of the upside may already be front-loaded.” In addition, there is no incentive for Singapore to raise interest rates given the soft economic growth and low inflation. Interest rates here are largely determined by global interest rates and interbank liquidity conditions, with the Monetary Authority of Singapore opting to use the Singapore dollar nominal effective exchange rate policy band as its monetary stance. On the recent hike in Sibor, Varathan cited “an avoidable by-product of policy and markets.”
Small window period to make the switch?
Darren Goh, executive director of MortgageWise.sg, advises borrowers not to delay their decision to switch to fixed rates as they will not stay at 2% for long.
“With Sibor back on its upward trajectory, we do think some banks will start to move up their fixed rates soon,” he says. Sibor has crept up again since August as the Singapore dollar slid against the greenback.
Paul Ho, chief mortgage consultant at iCompareLoan.com, says: “Fixed rates typically carry a premium of 0.3% to 0.5% over floating rates. This premium has thinned to just 0.2% (in some months) as banks have yet to adjust the fixed rates since June despite the recent hike in Sibor. However, some banks could lower the fixed rate packages to gain market share. When the 1.68% fixed rate package was launched, if I remember correctly, Sibor 3M was about 1% to 1.1% and the spread was about 0.8% to 0.9% on average. Hence, this fixed rate package is even lower than the floating rate package.”
Against this backdrop, now is the right opportunity to make a switch from floating to fixed rates. There is possibly another reason why borrowers should not delay switching from fixed to floating rates. If the premium for fixed rates were to return to the typical 0.3% to 0.5% over floating rates, the projected gradual increase in Sibor might be insufficient to offset this premium. In this case, switching to fixed rates might not result in any significant interest savings to the borrower.
On a closing note, MortgageWise’s Goh suggests that fixed rates might suit owner-occupiers better than investors. This is because selling the property within the lock-in period will attract a prepayment penalty, usually at 1.5% on the loan amount redeemed.
This article appeared in The Edge Property Pullout of Issue 69 (September 21) of The Edge Singapore.
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