Fixed or floating home loan – which is better?
If you've only a minute:
- A fixed rate loan is useful in a rising rates environment, since the borrower can “lock-in” the rate.
- With a floating rate mortgage, the interest rates are tied to a reference rate and the borrower will need to be prepared for any changes in the reference interest rates.
- Ultimately, it comes down to whether you prioritise certainty or the potential for lower interest rates.
Mortgage rates in Singapore have been heading north in line with global interest rates, with fixed home loan rates offered by local banks reaching up to 4.5% per annum (pa) by the end of 2022.
The increase in home loan rates is driven by various macroeconomic factors, such as the raising of the benchmark lending rate by the US Federal Reserve, as well as the high inflationary environment.
Rising mortgage interest rates – doubling within a year- is no doubt causing much stress to homeowners who are paying significantly more for their monthly home loan repayments compared to a year ago. For a homeowner who was paying a fixed rate loan of 2.5% pa on a $500,000 loan a year ago and now paying a fixed rate of 4.25%, his monthly repayments would have increased from $2,244 to $2,709, an increase of $465 or 20.7% per month.
Going forward, interest rates are likely to remain volatile. The question on many borrowers’ mind is: “Should I lock in a fixed rate home loan or opt for a floating rate package for potentially lower rates instead?
Fixed vs floating rate home loans – what are the differences?
A fixed rate home loan comes with an interest rate that remains unchanged throughout the lock-in period. A floating rate loan, on the other hand, varies throughout the tenure of the loan, depending on the rate at which the loan is pegged to.
As a fixed rate loan offers the borrower more certainty over the monthly repayment amount, the interest rate tends to be higher compared to the floating rate at the time the loan is processed. A fixed rate loan is useful in a rising rates environment, since the borrower can “lock-in” the rate and will not need to pay higher interest should rates continue to head north.
With a floating rate mortgage, the interest rates are tied to a reference rate and the borrower will need to be prepared for any changes in the reference interest rates. When the reference rate goes up, your monthly repayment will increase as well. Similarly, when the reference rate goes down, your monthly repayment amount will also decrease.
In Singapore, a floating rate home loan is usually pegged to the Singapore Overnight Rate Average (SORA) or a Fixed Deposit Based Rate (FDR). The 3-month compounded SORA has risen from 0.1949% at the beginning of 2022 to 3.0074% as of January 11, 2023.
Floating rates tend to be cheaper compared to fixed rate packages, which means paying a lower monthly instalment. However, there is less certainty on the repayment amount you will be paying as the rates are not fixed.
Some banks such as DBS also offers a hybrid home loan which allows borrowers to customise their home loan with both a fixed and floating-rate component. Borrowers get to enjoy the best of both worlds by having part of the loan amount under a fixed rate package for a peace of mind, and also benefit from the interest of a floating rate package for the remaining loan amount.
*Rates as of 12 January 2023
Choosing between a fixed and floating rate mortgage
With the current uncertain economic environment, many home-owners are finding themselves in a bind. “Should I choose a fixed rate loan to lock in current rates?” or “should I choose a floating rate loan since interest rates have already risen considerably in the last year and could peak soon?”
Ask yourself – Is the certainty of knowing how much you would be paying each month important to you? If it is, then a fixed rate loan might be a more suitable option because there would be no surprises. However, given that interest rates could fall in the next 1 to 2 years, borrowers might want to choose a shorter locked-in period for their home loan.
For others who hold the view that interest rates have peaked or that recessionary pressure is building up, getting a floating rate home loan may be more suitable. However, those who choose this option might want to set aside extra cash for buffer in case interest rates rise instead.
Before committing to a home loan package, make it a point to consider the relevant fees and conditions for refinancing or repricing. Home loan packages usually come with a lock-in period of at least 2 years. This means that you would not be able to pay down your loan or refinance to another financial institution without incurring penalty fees during the lock-in period.
Refinancing incurs valuation and legal fees which might add up to a hefty sum, so it is prudent to look at the package in totality, and not just the rates.
Tips to cushion the impact of higher mortgage repayments
1. Review your current home loan
Homeowners should re-assess the interest rate of their existing home loans and explore loan options where they can enjoy potential interest savings. You can use the DBS Home Loan Savings Calculator to calculate potential savings by repricing with your existing bank, or by refinancing with another bank.
2. Reduce your housing loan amount
If you have spare cash lying around or when you receive your annual bonus, you can consider partial repayments of your home loan to save on interest payments. Some banks may charge a fee for partial repayments, so weigh the pros and cons before you take action.
3. Use your CPF for your monthly home loan repayments
You can use the funds in your CPF-OA to service your monthly mortgage repayments, even if you are financing a private property. This can be done by submitting an online form via the CPF website.
Using your CPF funds to service your monthly loan repayments means that you will lose out on the interest earned on your CPF-OA account, which currently stands at 2.5% pa.
4. Extend your home loan tenure
Consider extending the tenure of your home loan so that you can pay a smaller monthly repayment. While this would mean paying more interest in the long run, it could be a temporary measure for the next couple of years to improve your cash flow and provide some breathing space.
The extension of your home loan tenure is contingent on the maximum loan tenure allowed - 30 years for HDB flats and 35 years for private properties on a bank loan.
5. Set aside excess funds as buffer
For those who are on a floating rate loan, you may consider putting aside more money per month into your home loan servicing account. For example, if you were previously setting aside $2,000 a month for your mortgage repayments, you may now want to set aside $2,500 instead.
Using this approach has two benefits – 1) it prepares the borrower for the possibility of higher instalments and 2) it “forces” you to set aside more as a financial buffer ($500 in this scenario).
6. Choosing an affordable home
For those buying a home, it is important to right-size their property purchase and exercise prudence. This is especially so as some economies may slip into recession, which may cause retrenchment or a period of low income.
New borrowers need to determine how much money they can borrow. The Total Debt Servicing Ratio (TDSR) has been tightened in September 2022 to cap your total monthly debt repayments at 55% of your gross monthly income. This means new mortgages cannot cause borrowers’ total monthly loan repayments to exceed 55% of monthly income.
Remember to factor in additional related payments such as property tax, property agent commissions, condo maintenance fees, insurance, home repairs or improvements, property loan interest and so on. Include other upfront costs, such as the down payment, stamp duties, cost of furnishings and any renovations.
Once you have chosen your loan package, do bear these in mind......
Just like investing in stocks or making financial decisions in general, it is wise to adopt a long-term view and be prepared for nasty surprises. Stay attuned to the latest trends and developments. Set aside emergency funds. The principle is to have enough cash or liquid assets for your monthly instalments over the next 2 years, even if you face unforeseen circumstances.
Start Planning Now
Check out DBS MyHome to work out the sums and find a home that meets your budget and preferences. The best part – it cuts out the guesswork.
Alternatively, prepare yourself with an In-Principle Approval (IPA), so you have certainty on how much you could borrow for your home, allowing you to know your budget accurately.
Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.