The Federal Reserve has increased interest rates for the first time since 2018 and laid out an aggressive plan to push borrowing costs to restrictive levels in the coming year, a pivot from battling the coronavirus pandemic to countering the risks of excessive inflation and the war in Ukraine. The U.S. central bank’s Federal Open Market Committee has also announced that it will officially begin the process of increasing interest rates!
So, if you’re thinking of buying a home or refinancing your mortgage, you’ll want to know what’s happening with interest rates in Singapore. Where are they now, and are they likely to head up or down? If interest rates are increasing, you might want to apply for that loan and lock your rate soon.
At Redbrick Mortgage Advisory, we aim to build a community of well-informed home owners and property investors. An understanding of the mortgage loan is therefore fundamental to sound financial decision making in the real estate market.
Let’s start with the basics of what a mortgage is all about for a soon-to-be 1st time home owner before delving into the advantages and disadvantages of fixed and floating rates.
What is a Mortgage?
When purchasing a home, you will pay a portion of the purchase price with cash (or CPF), while the remaining amount is funded with a home loan, otherwise known as a mortgage.
Components of Mortgage
There are a number of components within a mortgage. Firstly, the interest rate that is pegged to the home loan offered by the bank. The bank stipulates these mortgage interest rates and provides a range of packages which we will discuss in detail later in this article.
The loan amount represents the initial amount that you would borrow from the bank. Most mortgages are amortized over their lifespan, which simply means that each month, a portion of your monthly payment goes towards repaying the outstanding loan balance, while another portion contributes towards the interest rate on the loan. Borrowers are obligated by law to repay this principal (loan amount) in full, otherwise the banks have the right to foreclose on the property.
Monthly mortgage payments are made over the Loan Tenure, which is the period of which the borrower wishes to repay the loan. A 30-year mortgage would therefore have lower monthly payments as compared to a 20-year mortgage of the same principal. The downside is that the 30-year loan would experience interest payments over a longer period.
Banks earn money through interest payments, and therefore impose a lock-in period on mortgages to prevent early repayment of the loan. This lock-in period differs across packages, and an early repayment may sometimes result in a penalty charge to the borrower, so be mindful with selecting your loan tenure!
Finally, the loan must be fully repaid at the end of its tenure, on the maturity date.
Mortgage Packages
Banks offer either fixed or floating interest rate packages. While these two product packages each present some benefits, they are not without their limitations.
Fixed Interest Rates
Fixed Interest Rate packages imply that the interest rate charged on the mortgage does not change throughout the tenure of the mortgage. These fixed rates are set by the bank. Fixed rates are offered for a duration of 1-3 years.
Benefits
The clear benefit of a fixed interest rate package is that there is a degree of certainty for the duration in which the interest rate is fixed, providing greater stability in your monthly interest payments.
This is most useful in a rising interest rate environment. A fixed interest rate package charging 2.0% interest rate will remain stable throughout the fixed period (often 1-3 years). If the market interest rate increases to 3.0%, you will benefit by paying a lower interest rate.
Limitations
However, this certainty comes at a price, as fixed interest rate packages are typically charge at a higher rate than the given floating rate at the time of which the loan is processed. This certainty also comes at the cost of added flexibility since you are locked into this loan.
In a falling interest rate environment, this flexibility may be detrimental since the borrower may end up paying a possibly higher interest rate. Suppose a fixed interest rate package charges 2.0% per annum. The borrower will be obligated to pay that 2.0% for the lock-in period even if interest rates fall below 2.0%.
Effectively, in a falling interest rate environment, a fixed rate mortgage may result in the borrower paying more on interest as compared to that of a floating interest rate. Some banks may offer a penalty-free option to switch between floating and fixed rates, but there are additional clauses within each mortgage package, so we advise caution in reading your mortgage documents thoroughly.
Floating Interest Rates
For floating interest rates, there are 3 different types of rates. They are your board rate, fixed deposit rate and SORA. Now board rates are simply a bank managed rate, and the bank has full discretion on how they want to move it.
For fixed deposit rates, this is the same interest rate that banks pay their fixed deposit customers. The banks will use this rate, plus a spread added on top of it to give you your mortgage rate.
For SORA, it is a volume-weighted average of borrowing transactions in the unsecured overnight interbank market. SORA is based on interbank transactions, it offers better visibility on interest rates and thus, your mortgage loan instalments.
Benefits
SORA can be found on the MAS website and can be easy referenced. This makes floating rates more transparent, as compared to fixed rates.
When interest rates are relatively stable or falling, SORA would allow you to capitalise on lower monthly repayments. As such, one would opt for a 1-month SORA to take full advantage of these falling interest rates.
This also provides greater flexibility for early or partial prepayments on their mortgage without incurring any penalty.
Limitations
With a floating rate package, you lose the certainty seen in a fixed rate mortgage. Consequently, you may expect to see greater fluctuations in your monthly loan payments depending on the interest rate environment.
It is also important to note that banks charge a spread on top of the quoted SORA. These spreads are subject to change over the course of the loan tenure, which may lead to higher monthly payments than one may initially expect.
In a rising interest rate environment, borrowers opting for a floating rate package would be susceptible to these interest rate hikes. In comparison, a fixed rate packages would be best used in such a situation. It is common that floating rate packages are marketed more attractively, and fixed rate packages are structured less attractively. The opposite would be true in a period of falling interest rates. We highly recommend assessing the loan holistically, taking into consideration the added fees and potential penalties involved, while having a 20 to 30-year forward planning view.
Optimising your monthly payments on your mortgage
Refinancing at a lower interest rate
Imagine that you have a fixed rate mortgage which charges a 3.0% interest rate, and you have just completed your lock-in period. You spot a floating rate package which currently offers a 1.5% interest rate. To effectively reduce your monthly payments, you could choose to refinance your property.
The savings generated through refinancing could be a few hundred dollars monthly, but the long-term savings may be significant over the tenure of the loan if the benchmark rates remain low.
It would be time-consuming and stressful to continuously monitor the movements of the interest rates, so do speak to a Redbrick Mortgage Advisor to optimise your real estate portfolio in line with your long-term goals!
Conclusion
The recent frenzy in the market could be attributed to many people capitalising on the low interest rate environment. Governments around the world have slashed interest rates to combat COVID-19’s detrimental effect on the economy. As the world begins to recover and normalise, the U.S. central bank’s Federal Open Market Committee has announced that it will officially begin the process of increasing interest rates and there are more interest rate hikes expected in 2022.
For local real estate investors and potential homeowners, proper financial strategizing is even more pertinent in view of recent updates to cooling measures. It is best to speak with our Mortgage Advisors to gain insights and guidance before planning the next step in your real estate journey.
