Longer fixed rate mortgage loans are not necessarily good for borrowers, Tharman

The benefits of longer fixed rate mortgage loans do not necessarily outweigh their costs and risks to home loan borrowers, said Tharman Shanmugaratnam, Senior Minister and Minister in charge of Monetary Authority of Singapore (MAS).

Longer fixed rate mortgage

Mr Tharman was responding to a parliamentary question by Assoc Prof Jamus Lim, a Member of Parliament from the Workers’ Party. Assoc Prof Lim had asked if the Government has engaged local banks to understand what the primary inhibitions are that preclude longer fixed rate mortgage loans from being offered and conducted any studies on whether the absence of a separate, government-backed home mortgage company has inhibited local banks from offering longer fixed rate mortgages.

Longer fixed rate mortgage loans do not necessarily outweigh their costs and risks to home loan borrowers

Replying to Assoc Prof Lim, Mr Tharman said:

“The benefits of longer-term fixed rate mortgage loans do not necessarily outweigh their costs and risks to borrowers.

“There are two pertinent considerations. First, mortgage loans with a longer period of fixed rates offer repayment stability but could come at higher costs over the lifespan of the loan. Financial Institutions (FIs) offering fixed rate loans bear the risks of interest rate volatility and higher opportunity cost of funds when rates rise and will price them at higher interest rates than floating rate loans. This can already be observed in the market today; for example, the introductory rates for a 2-year fixed rate mortgage loan offered by the local banks currently range from 3.5% to 3.75%, higher than those for floating rate mortgage loans of about 3.0% offered by the same banks.

Second, borrowers may not have as much flexibility to refinance their loans when interest rates fall, as longer-term fixed rate loans come with longer lock-in periods. Whether the longer-term fixed rate loan benefits the borrower depends on the interest rate conditions when the loan is taken up. In a period of higher and more volatile interest rates, such as what we face currently, borrowers who enter into longer fixed rate terms are at risk of being locked in at such higher rates, for a longer period. This means that should interest rates eventually decline, these borrowers may not have the option to refinance out of their loans or may have to incur substantial costs in doing so.

“Local banks currently offer a range of mortgages with rates that are fixed for up to 5 years. According to the banks MAS has engaged, these offerings reflect customer preferences. Borrowers generally prefer near-term certainty in their monthly repayments while still having an avenue to refinance their loans later. MAS has received feedback from the industry indicating that customers had a generally tepid reception to previous launches of longer-term fixed rate mortgages.

“In the United States, government-backed home mortgage companies (namely Freddie Mac and Fannie Mae) were established to provide liquidity, stability and affordability in the mortgage market. They purchase mortgages from lenders to either hold or repackage, guarantee and sell them as mortgage-backed securities in the secondary market, thus making more capital available for lenders to provide new mortgages. Singapore’s FIs have sound capital positions and stable funding. Their mortgage lending approach is not constrained by a lack of available funding, and they have been able to meet customers’ needs without any support from government-backed entities.”

Last month, customers of three major banks woke up to a rude shock due to the home loan fixed interest rate hike unseen in recent years for residential property mortgages.

Some homeowners who opted for a bank loan to finance their mortgage have been left in shock after the three major local banks announced on October 4 that the fixed interest rate for housing loans will be raised to a maximum of 3.85 per cent.

UOB claimed that more customers were now asking for repricing and refinancing than those who were a year ago, in line with market trends in a rising interest rate environment. DBS and OCBC pointed out that more customers have recently sought stable mortgage rates.

Financial consultants generally advise that it is best to limit your monthly debt repayments to 35 per cent or less of your income, so you should be able to handle it no matter how high the interest rate is. Also, If you’re cash-flow tight right now, or your income isn’t stable, then longer fixed rate mortgage loans are the types of home loans you should be looking at.

Experts have advised that homeowners who want to feel at ease should seriously consider whether bank interest rates will really serve them well since it may be lower in the short term but heftier as time goes on.

“As long as property sentiments are positive, I do not see interest rates as being a very big deterrence for people buying property,” said Mr Paul Ho chief officer at iCompareLoan.

The home loan fixed interest rate hike have not affected the public housing resale market substantially, as the loan quantum of most HDB flats is not high, and most homeowners are not over-leveraged.

“As for the private residential property market, most existing homeowners should be able to service their home loans now. However, the home loan fixed interest rate hike are more likely to be keenly felt once they edge past the 3.5 or 4 per cent mark,” said Mr Ho.

The total debt servicing ratio (TDSR) threshold for property loans uses a stringent 3.5 per cent interest rate computation which should be sufficient buffer for rates to move before monthly mortgage obligations exceed borrowers’ gross monthly income.

“For buyers of HDB flats and are taking up an HDB loan, the good thing about it is that they have the flexibility of refinancing to a bank loan if they ever change your mind because it does not have a lock-in period. But if they are taking a bank loan, there is no way they can refinance to an HDB loan,” said Mr Ho.

“They should also read up on good guides on refinancing in Singapore,” he added.

Buyers will only likely start going easy on investing if the positive property market once the interest rates go up to 4 or 5 per cent with bank home loan hikes, and affect their disposable income.

The increased public housing supply with launch of more BTO flats in the second half of this year is expected to draw demand away from the resale market. This is also expected to regulate the pace of price growth and tame market exuberance.

As for the prices of new homes, excluding executive condominiums, prices may rise by 6 to 9 per cent this year as compared with 2021, while around 9,000 to 10,000 units may be transacted.

On the whole, the resale market prices for 2022 may increase by between 6 and 8 per cent from the previous year.

Positive side of interest rate environment

Today, consumers not only can opt for longer fixed rate mortgage loans, but have a wide range of home loan packages to choose from compared to several years ago, and this is a huge advantage to home buyers and investors.

Home loans could also be tied up with other programmes which rewards customers with a higher interest rate on their deposits if they transact more with the bank, such as getting a home loan and crediting their salary with the same bank.

Typically, with mortgage loans you are offered attractive rates for the first three years when you refinance – following which the interest rates are adjusted upwards. This usually coincides with the end of the lock in period, offering borrowers a good opportunity to relook their loans.

Those who already have a home loan with a lender you are comfortable with, should consider repricing, especially with the recent home loan fixed interest rate hike.

Repricing refers to switching to a new home loan package within the same bank while refinancing refers to closing your current home loan account and setting up a new home loan account with another bank.

A repricing typically occurs when new incremental loan facilities and/or refinancing facilities are introduced into the same documentation as an existing loan. The proceeds from the new incremental loan facility will have a lower margin and will be used to repay the existing loan.

While repricing lets you replace your existing loan with a new loan with the same lender that potentially has a new interest rate or revised repayment timeline, refinancing might be a good option if interest rates have dropped or are lower than your current rate, or if you need to extend your repayment term.

When considering refinancing versus repricing, remember that securing longer fixed rate mortgage loans may not be the best outcome to secure lower interest rates. Lower interest rates will reduce your cost of borrowing so you’ll pay less on your home loan, overall.

Written by Ravi Chandran

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