The impact of rate reductions on your home mortgage

As fixed mortgage rates have dropped to 3 per cent from the usual floating rate of 4 per cent or more, it would seem a no-brainer that you should choose the lower loan.

The problem comes from an outlook which indicates that interest rates are expected to drop in the second-half of 2024. Jerome Powell from the US Federal Reserve said after last month’s Federal Open Market Committee Meeting (FOMC), that nearly everyone on the FOMC is in favor of lowering rates this year.

Powell reacted by pushing back against the notion of a rate cut at the next meeting scheduled for March. But the market seems to be pricing in rates to drop in either May, or June.

Contrary to analysts’ predictions and forecasts as well as the narratives of each month, the cycle behaves like one. For example a Fed pivot last November has become a Fed reversal now. After a short time, the cycle will return to its normal state.

You can choose the second option if you think that interest rates will drop faster than expected or if mortgage prices are revised. The fixed rate will be reduced to 3.1 per cent by mid-2026.

The fixed mortgage rate fell dramatically at the start 2024 in comparison to the beginning of the year 2023. It went from 4% down to just 3%. It is impossible to predict if they won’t drop another 100 basis-points, or 2 percent by the end of 2025. This will happen after the Fed reduces its hikes starting in mid-2018. The Fed’s pace will determine whether or not we experience a soft landing in America.

Even if this time the reduction is only 0.5 percent, it still amounts to S$3,500 for an average mortgage of S$700,000. This amount can be much higher if you have a large loan.

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A new home loan package will likely not include floating rates higher than 4%. What do you do? Do you opt for the lowest nominal rate, which is for a fixed-rate two-year package with two-year commitment (lock-in), a higher fixed-rate that offers an option to reprice and convert a 12 month period into a lock-in of two years or go with a slightly more expensive fixed-rate that gives you a choice between a lower fixed-rate with a longer commitment period or a higher fixed-rate that allows you to choose a slightly increased fixed-

Remember that only a few weeks ago, it was said that rates would continue to rise. As it turned, the inflation rate is no different. It is indeed temporary, but this temporary period lasted just two years. The inflation now is declining.

However, there is still a chance that many of us will be in the wrong. Our firm recommends that you choose the lowest-fixed rate mortgage with the shortest time commitment and retain the option to review the loan after a year. This can make the difference of S$700 (0.1%) or S$7,000 (10%) on an average S$700,000.00 mortgage over a single year.

However, there is an issue with this approach. Even as recently at October and December 2023, banks had thrown everything they could to grab market share. This included offering the lowest rate fixed, a year-long lock-in, the lowest after-fixed spreads, free conversions, and even enhanced rebates of up to S$500 for refinancing. At the moment there are fewer options than during such brief spells.

The banks seem to have stopped giving rates below 3% when 2024 came around. You would have expected banks to seize this window of opportunity before the Fed reduces rates and SORA drops in the second halves of the year in order to capture the sweet spot of lowest rate with optionity in 2024. This would lead to higher margins as the cost of funds subsides.

Many analysts advise that you should not fixate on the difference between a package that has a 2-year lock-in and one that offers an optionality of a year.

The average rate of interest over the next four years will be less than 2 percent. This is an amazing feat, especially in this period of Fed rate hikes that have broken all records.

Consider two factors. It is possible to ignore the 0.1 per-cent and continue with the option of repricing after 12 months.

If the percentage is higher than 0.1, it all depends on how you look at it. If you were one of the lucky few who had a mortgage rate that was below 1.5 percent in 2022 and locked it down, you may want to adopt a blend cost of funds approach by locking the lowest rate for two years.

Be careful if, in recent years, you have paid more than you can afford. A recession or other unexpected events could force you to pay higher rates. We live a world that is uncertain.

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