3.5% and 3.85%. No, these are not your next 4D issues, but rather some of the latest fixed interest home loan packages from DBS, OCBC, UOB and HSBC.
For example, DBS offers a fixed interest rate of 3.5% for lock-up periods of two to five years inclusive.
Why are banks like DBS increasing fixed rate mortgages again so soon?
Wait, haven’t the banks adjusted their fixed interest rate recently? Well, you’re right to point that out.
Indeed, a little over a month ago, the banks adjusted the rates of their fixed-rate mortgages. And yes, they are starting again now. Let’s explore three reasons why.
1. The US Federal Reserve plans more warmongering
Since the world depends on the US dollar as a reserve currency, any decision made by the US Federal Reserve (the Fed) will certainly have an impact on the rest of the world.
Right now the Fed needs to suppress the high levels of inflation in the US economy. And how is the Fed handling this? By raising interest rates.
For context, the effective federal funds interest rate rose from 0.08% in January 2022 to 3.08% at the end of September 2022. In the space of nine months, interest rates have increased at speeds unprecedented in recent memory.
Despite rate hikes, inflation remains persistently high. The Fed therefore believes that it has no choice but to continue this rate hike to cool the economy until the inflation rate returns to an acceptable level of 2%.
This is impacting the rest of the global economy as almost all other central banks are following suit to raise their interest rates.
2. Banks face an upward push in the cost of deposits
For those unfamiliar with how banks work, here is a brief overview of the banking business model.
Banks take deposits from customers like you and me. In exchange for the deposits, the bank offers a safe place to keep the money and pays a small interest rate to entice you to put your money with them.
The bank then uses part of these deposits that its customers have placed with it to finance its lending activity. For example, they lend money to homeowners looking to finance the purchase of their home.
The bank then earns from the interest rate difference, which is the difference between what it offers on its savings account and what it charges on the mortgages.
Over the past few months, we have seen an increase in the cost for banks to obtain deposits from customers.
This is largely due to interest rates rising as the Fed battles inflation. As a result, the cost of fixed deposits is now close to the 3% mark for a 12-month fixed deposit.
Since the cost of fixed deposit is rising, banks have no choice but to increase the interest rate on their home loans so that they can still earn a decent margin when offering home loans.
3. Interest rates are expected to continue to rise, so banks need a bigger margin of safety
When banks offer fixed rate mortgages, they take on a certain level of risk. This is because if the fixed interest rate they set is ultimately lower than the interest rates they charge on their variable rate plans, then they lose (or rIGU in Bahasa Melayu).
It’s true – banks may be customer friendly, but they are still businesses at the end of the day.
This is why fixed interest rate mortgages are generally more expensive than variable rate mortgages. You pay extra for the extra security and reinsurance, and the banks are hedging their bets that home loan interest rates will never go higher than what they charge you.
For example, those who took out home loans in October 2021 would be offered fixed rate packages as low as 1.5% and even lower floating rates!
A year later, those with fixed rates are still enjoying 1.5%, but those with floating rates will be paying around 2.25% now. (Which is still better than what they would pay if they refinanced today!)
So whenever the bank sets a fixed interest rate, it needs to ensure that there is a healthy margin to avoid any scenario where it carpet.
Banks also don’t want to be caught off guard by having their fixed interest rate set below their cost of borrowing.
With interest rates expected to rise, the defensive move banks can make is to give themselves a bigger margin of safety.
This is done by increasing the fixed interest rate on home loans so that there is less chance that the banks will end up making a loss.
What should owners do now?
1. Keep your affordability under control
As an owner, there is little you can do to change the minds of the Fed or the banks. However, there is something you can do in your power, and that is to control your financial capacity.
The biggest concern for homeowners in a rising interest rate environment is that you may one day not be able to pay the monthly mortgage payment on your home.
This especially applies to homeowners who have taken advantage of plenty of cheap credit over the past decade.
To avoid this, one solution is to consult a mortgage advisor before committing to buying your next property.
A mortgage advisor will be able to advise you on the maximum limit of your loan amount based on current Total Debt Service Ratio (TDSR) regulations.
They will also be able to let you know if you are affected by the property’s recently announced cooling measures. This is especially important if you have other debts (eg car, children’s education) that you need to take care of.
2. Should you choose a fixed rate mortgage rather than a variable rate one?
The age-old dilemma of many homeowners is back to haunt us all over again. As a homeowner, should you choose a fixed rate mortgage over a variable rate mortgage?
Remember our friends at the Fed? Based on their last meeting last September, they indicated that they expect interest rates to continue to rise for at least two years, peaking next year and not returning to the level current than in 2025.
Therefore, a two-year fixed interest rate package is much more conservative than a one-year fixed interest rate home loan package, but a three-year package and beyond should only be taken out than by those who prefer to pay a premium for security.
Variable rate mortgage packages are always an option, of course, and in the short term will still cost you less than a fixed rate package, but nothing less than a global recession (which is unfortunately still possible) would make it the better option over a fixed-rate home loan for at least the next two years.
3. Review your existing home loan to ensure your interest rate is still competitive
For existing homeowners, rising interest rates are a good reminder to start taking your home loan seriously if you haven’t.
If it’s been three or four years since you last signed on your home loan, chances are you’ll be paying a higher interest rate than you’d get if you were to refinance it.
This article first appeared in Mortgage Master.