What rate reductions can do to your home loan

The fixed rate mortgage is now 3 percent, while the floating rates are mostly over 4 percent. One would think that choosing a cheaper loan was a simple decision.

The complexity comes from a projection that shows interest rates falling from the second quarter of 2024. Jerome Powell of the US Federal Reserve had said that, following last month’s Federal Open Market Committee meeting (FOMC), almost everyone is in favor moving rates down in this year.

He then resisted the idea of the first rate reduction at the next FOMC meeting in March. However, the market has now priced in a cut to begin in May or in June.

Newport Residences Pricing will be released closer to the launch date in March 2024.

Rates on fixed mortgages fell from 4% to 3% at the beginning 2024. Nobody can say for sure that rates will not drop by another 100 basis point to 2% by 2025 after the Fed has started reducing its rate hikes. The Fed’s speed will determine how much the Fed cuts. This is dependent on if we have a soft or a hard landing in the US.

Even if it is reduced to 2.5 per cent this time, that is still 0.5 per cent. This translates into a savings of S$3,500 a year, for a typical loan of S$700,000.

Anyone considering a new home-loan package today will not choose floating rates above 4 percent. You have to decide: do you take the lowest nominal-fixed-rate package available – which comes with a commitment period of two years (lock-in) – or do you take a slightly higher-fixed-rate package that has an option for reprice or conversion from 12 months into two-year lock in?

The second option allows you to switch from a fixed rate to a floating one if rates fall more rapidly than anticipated and mortgages are re-priced. So, you will not be locked into a high 3,1 per cent fixed-rate mortgage until mid-2026.

Analysts’ predictions, projections, and narratives can change from month to month. For instance, a Fed shift in November of last year is now a Fed pushback. But the cycle still behaves like a regular cycle. The cycle is a constant, which means that after a brief period of time at the top, what went up will always come down.

Remind yourself that just a couple of months ago, the narrative was that interest rates would remain higher for a longer period. It turned out that inflation was not different from other periods of inflation and it is also transitory. But this period lasted only two years. Now inflation is coming down.

Of course, we could all be wrong. The best strategy, according to our firm, would be to select the lowest fixed rate and the shortest term of commitment. We’d also keep the option of a 12-month review. This could be the difference between S$700 (0.1%) and S$7,000 (1.0%) on a S$700,000 typical mortgage in a year.

But there is a problem. Banks pushed all the stops in order to gain market share as recently as October and Novembre 2023. For example, they offered the lowest fixed rate and a one-year locking-in. Then, after the fixed ended, they offered the lowest spreads and free conversion. The options are not as plentiful at the moment, unlike in brief spells such as those.

When the year 2024 arrived, it seemed that banks stopped giving out rates under 3 per cent. You’d have thought that banks would grab the opportunity to get the best rate before the Fed and SORA cut rates in the second part of the year. They could then gain the most market share for 2024.

Many analysts also caution against getting fixated on the tiny difference in fixed rate packages, between those that come with a strict 2-year lock and those that have an optionality at one year.

Consider two things: First, the size of the gap. Consider the following: If this gap is only 0.1 per cent in size, you can probably ignore it and retain that option for a reprice at 12 months.

The perspective you choose will depend on whether the difference is greater than 0.1 percent. If you’re one of the fortunate ones who was largely protected from the high rates of mortgages in the last two year, and have locked down a fixed-rate below 1.5% by 2022, you could adopt a blended costs of funds perspective, pursuing the strict two-year locking with the absolute lowest rate today.
Your average interest costs over the four-year period are likely to be around 2 per cent. This is a remarkable achievement in an era of unprecedented Fed rate tightening.

You should also be aware that if you paid through the nose the last few year, you may find yourself in a similar situation again. For example, you could be stuck paying a higher rate of interest while you watch the rate cascade as a result of a sudden recession or other exogenous events. We live in an unpredictable world.

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