Your home loan can be affected by rate cuts

If you compare the fixed rates of today, which are at only 3 percent to the higher floating rates that hover around 4 percent, it seems like a nobrainer.

The complicating factor is that the outlook indicates that rates will start to fall in 2024, starting from the second halves. Jerome Powell stated, after last month’s Federal Open Market Committee (FOMC), meeting that almost all members of the committee are in favour moving rates lower this year.

He also pushed against a first cut of rates at the meeting next month in March. However the market is pricing in rate cuts starting in May and June.

Fixed mortgage rates were down significantly in 2024 as compared to those at the start to 2023. They went from 4% to only 3%. The Fed will begin to reduce its hikes by the middle this year. The Fed’s rate of change will determine how far the cuts go. That in turn is based on the outcome of a US soft or hard landfall.

Even if the decrease is halved to 2.5%, this is a saving of 0.5 %, or S$3,500 over a period of a single year for a mortgage loan of S$700,000.

The floating rate on a new mortgage package is likely to be higher than 4 per cent. The question is: Should you choose a low-priced fixed-rate option that includes a two year commitment period (lock in) or should you choose a slightly-higher fixed-rate deal that includes an option of repricing or converting 12 months to a two year lock-in?

By choosing the second option, you will be able to change your rate to a flexible one in case interest rates decline faster than expected. It means that you won’t need to settle for a high 3.1% fixed rate until 2026.

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In spite of analysts’ forecasts, narratives and predictions that can shift from one month to the next – for example, a Fed turn in November 2017 became a Fed pushback today – the cycle keeps on behaving like a normal cycle. It means that whatever goes up must come down after briefly being at the top.

It was only a matter of months ago when the narrative said rates would be higher for longer. As it turns out, inflation has been transitory for the past two years.

It is possible that some of us are still wrong. Our firm suggests that the best way to proceed is to opt for the lowest interest rate, with the shortest commitment period. You can also choose a review option after 12 months. It can mean the difference in saving S$700 (0.1%) or S$7,000 (1) on a mortgage of S$700,000.

The problem is that this approach does not work. Even in October 2023 and November 2023 the banks made every effort to capture market share. For instance, they offered a low fixed rate with a 1-year lock-in. After the fixed term ended, their spreads were the lowest. There are few options available at the present time, unlike brief spells of that nature.

After 2024, the banks seemed to stop offering rates lower than 3 percent. You would have assumed that banks would be able to take advantage of this sweet spot before the Fed lowers rates, and SORA falls in the latter half of the calendar year. To gain the greatest market share in 2020, they would then increase their margins when the cost of funding subsides.

Many analysts will also tell you to not get fixated by the slight difference between fixed rate packages that are locked in for two years and those with an optionality that is available after one year.

First, how large is this difference? If the gap is just 0.1 percent, it may be worth ignoring and keeping that option to reprice within 12 months.

It all depends what you think. If you are among the lucky few that have been protected from high mortgage rates over the last couple of years and have locked in a fixed rate of less than 1.5 per cent for 2022 you can adopt the blended cost of fund perspective by following a strict 2-year lock at the absolute lowest fixed interest rate today.

It means that the average interest you pay over a four year period is less than 2%, which is remarkable in a time of record-breaking Fed tightening.

But if in the past you have paid a lot of money, don’t get trapped again. We live an uncertain world.

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