Why home buyers should get fixed rate home loans NOW

With interest rates set to rise this year, it is probable that home owners will face higher mortgage repayments. Property loans in Singapore have been at record lows since 2008, when American stimulus efforts during the Global Financial Crisis brought down interest rates. However, we now have clear indications that this period is at an end.

Floating versus fixed rate home loans

Singaporeans who purchase private housing (including Executive Condominiums), or choose to use a bank loan rather than HDB Concessionary Loan for their flat, must pick between fixed and floating rate loans.

With fixed rate home loans, it means monthly payments do not change, for the duration of the fixed rate. This is typically three to five years. Fixed rate home loans tend to cost slightly more than their floating rate counterparts, as the bank is guarding itself against potential rate hikes.

A floating rate home loan is (usually) pegged to the Singapore Interbank Offered Rate (SIBOR). The SIBOR rate tracks the interest rates among local banks, and fluctuates on a regular basis. As SIBOR rises or falls, the interest rate on a home loan will move accordingly.

Note that there is no perpetual fixed rate home loan in Singapore. All loan packages eventually revert to floating rates at the end of the fixed rate period. The closest Singaporeans can get to fixed rates are:

• Semi-fixed rate, which means constantly refinancing from one fixed rate package into another
• The HDB Concessionary Loan, while it is not technically a fixed rate*, has been unchanged at 2.6 percent interest for many years. Still, this is only an option available to Singaporeans purchasing HDB properties, excluding Executive Condominiums.
• Getting a special mortgage from a foreign or private bank, which offers perpetual fixed rates. However, this is not an option open to most Singaporeans.

*HDB loan interest is always 0.1 percent above the prevailing CPF Ordinary Account (OA) interest rate. The CPF OA is reviewed quarterly, but seldom changes.

Why do you want to get a fixed rate soon?

Fixed rate packages are being pulled from the market, due to the banks expecting a series of rate hikes. To understand how this affects you, you must understand how home loan interest rates are calculated.

In a typical floating rate home loan, the interest rate might be expressed as follows:

• (Year 1): 3 Month SIBOR + 0.7
• (Year 2): 3 Month SIBOR + 0.7
• (Year 3): 3 Month SIBOR + 0.7
• (Year 4 and thereafter): 3 Month SIBOR + 1.0

Note that the “3 month” indicates the interest rate period. This is how long it takes for the interest rate to be revised to match the prevailing SIBOR rate. A 1 month SIBOR rate means repayment amounts would change every month, whereas a 6 month SIBOR rate would mean repayment amounts change semi-annually.

Assuming the 3 month SIBOR rate remains at around 0.96 per ent (this is the current SIBOR rate at the time of writing), the interest rate is around 1.66 percent for the first three years (0.96 + 0.7), and around 1.96 percent from the fourth year to the end of the loan tenure.

You can see, however, that spikes in the SIBOR rate – such as if SIBOR were to climb to 1.2 percent by end 2017 –represent a significant financial burden on borrowers.

Fixed rate home loans are an attempt to mitigate this. Fixed rate loans do not fluctuate for a period of three to five years – the interest will be expressed as a fixed amount (say 1.8 percent per annum) for the duration. However, note that the average cost of the fixed rate loan tends to be higher.

Give the current economic situation, the demand for fixed rate home loans will increase

As demonstrated above, our home loan rates are dependent on SIBOR. The SIBOR rate is, indirectly, dependent on the state of the American economy.

The American Federal Reserve (the Fed) is raising its interest rates, on the back of a recovering economy. There are three planned rate hikes in the coming year, with Nomura predicting that SIBOR will hit 1.35 percent by Q2 2017, and 1.6 percent by Q4 2016.

By our estimates (most banks have “fourth year and thereafter” rates of 0.9 to 1.2 percent), this could put interest rates for private homes on par with the cost of a HDB loan. Private bank loans have been cheaper than HDB loans since around 2008, which once motivated many HDB borrowers to refinance into bank loans.

Borrowers will likely rush to secure good fixed rate options on the market, to shield them for the next three to five years.

There is no need for home owners to panic or overreact

The rise in interest will not, as naysayers are prone to claim, result in thousands of home owners being forced to sell.

Assume you have a 25 year loan for $800,000, at a rate of 1.8 percent per annum. The monthly repayments would be around $3,133 per month. Now if the interest rate were to jump significantly – say to HDB levels of 2.6 percent – the monthly repayments would instead be $3,629 per month.

Granted, an extra $496 per month is painful to borrowers; but it is not an amount that would force most families into downsizing or homelessness.

The rise in interest rates will be more of a concern to landlords. It can be quite difficult to raise your rental income by $496 per month, especially in Singapore’s softening rental market. In this sense, landlords should be even more eager than home owners to refinance into fixed rates.