Rate cuts and your home loan package matters

Fixed mortgage rates are now significantly lower, at just 3%, compared to the floating rates, which hover mainly above 4%. It would seem that it’s a no brainer to choose the cheaper loan.
A complication arises from a forecast that indicates interest rates will be falling in the second half 2024. Jerome Powell, the US Federal Reserve Chair, had stated that after the Federal Open Market Committee’s (FOMC) last month meeting that almost everyone on the committee was in favor of moving rates downward this year. The Fed chair pushed back on the idea that the first rate cut would be made at the March meeting, but the market now prices in a reduction to start in either May or June.

Mortgage rates dropped significantly from 4 percent to 3 percent at the beginning of 2024 compared to 2023. After the Fed begins to dial back its hikes in the middle of the year, no one can guarantee that the rates won’t fall another 100 basis points by the beginning of 2025. How fast the Fed acts will determine the extent of the cuts, which in turn depends on whether the US has a hard or soft landing.

If the rate is cut in half to 2.5 percent, then that’s a 0.5 percent reduction, which is equivalent to S$3,500 per year on a mortgage of S$700,000.

Today, anyone looking for a home loan package is unlikely to choose floating rates that are still above 4%. It is a question of whether you choose the lowest nominal fixed rate available, which is a package with a 2-year fixed rate and a 2-year commitment period. Or do you opt for a slightly higher fixed rate with a reprice option or a 12-month lock-in that can be converted to a 2-year period?

If interest rates fall faster than expected, you can switch to a variable rate. You won’t have to pay a high fixed rate of 3.1 percent until the middle of 2026, for example.

Explore more on Bagnall Haus at Upper East Coast Road.

The cycle is still a cycle, regardless of what analysts predict, forecast, and the narratives that are being told. For example, the Fed pivot from November last year has now become a Fed pushback. What goes up, comes down. It can go down as quickly as it went up.

Just a reminder, just a few short months ago the story was that rates were going to stay higher longer. Inflation is transitory and not a new phenomenon. However, this transitory phase lasted for two years, and now inflation is decreasing.

Many of us may still be wrong. Our firm believes that the best option is to choose the lowest rate fixed with the shortest period of commitment, while keeping the flexibility of a review at the end of the year. It could mean the difference between S$700 (0.1%) or S$7,000 (1%) in savings on a typical S$700,000.00 mortgage.

This approach has a flaw. In October and November of 2023, the banks were at their most aggressive in gaining market share. They offered, for instance, the lowest fixed rates, a lock-in for one year, the lowest floating spreads thereafter after the fixed period ended, free conversions during the lock-in two-year period, and enhanced cash rebates when refinancing by an extra S$500. Options are currently limited, unlike during those brief periods.

As the year 2024 approached, it seems that banks stopped offering rates below 3 percent. You would think that banks would take advantage of the opportunity before the Fed cut rates and SORA dips during the second half year to offer the lowest fixed rate combined with the option to pay more, in order to gain the largest market share by 2024.

Analysts also warn against focusing on the small difference between two fixed-rate packages: one with a two-year-long lock, and another with an option after one year.

Two factors are important: first, what is the size of this gap? You can ignore it if the difference is only 0.1 percent and still keep this option to reprice in 12 months.

It depends on your perspective if it’s greater than 0.1 percent. You may be one of the lucky ones, who have been shielded by the high mortgage rates in the past two years. If you have locked in a rate below 1.5% for 2022, then you can take a blended cost perspective.
This means that your average interest rate over a 4-year period will be close to 2 percent, an impressive feat during a period when the Fed is tightening rates at a record-breaking pace.

If you’ve been paying through the nose for the past few years, you should be careful not to get caught in the opposite situation – being forced to pay a high interest rate and watching it cascade because of a recession, or an unexpected event. We live in a world of uncertainty.

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