Wednesday, August 09, 2006

Housing Loans - Fixed or Variable Rates?

Aug 8, 6:11 PM EDT

Fed Leaves Key Interest Rate Unchanged

AP Economics Writer

WASHINGTON (AP) -- With the economy losing momentum, the Federal Reserve halted the longest unbroken stretch of interest rate increases in recent history Tuesday - a reprieve for millions of borrowers after more than two years of rate pain.

In my line of work, I talk to clients about their mortgages. The current trend is for everyone for look for fixed rates which in my mind is a BIG mistake.

Let's look at the facts, interest rates have been going up and up in the last 2 years, more or less in tandem with the increases in the Fed Funds Rates. In the US, home loan rates are tied up directly to this Fed Funds Rate. In Singapore, however, there is no one rate which ties up all the rates in Singapore. Instead, each bank would have its own Board Rates. These rates can be arbitrarily changed by the individual banks, with no need for any justification to be made to any of their clients. The board rates are loosely linked to the Fed Funds Rates. Most banks, however, looks at the 3-month-Interbank rate when determining whether or not to raise their board rates. (although I totally disagree.. more on that in another post, if I'm in the mood :o) )

2 years ago, when rates were low, clients objected to fixed rates when you mentioned them. Even when rates turned upwards, clients continued to believe that rates would continue to remain relatively low. However, in the last year or so, clients have begun feeling more pain financially. All of a sudden, going "fixed" became more important. In a conversation with a client yesterday, he made it very clear that he would only consider going fixed; "too much lah... the other bank increase so many times... very chia lat you know" was his lament.

The signals have changed. In the last 6 months, the Fed had changed the language of its releases. Then last night it happened. They've stopped the back-to-back interest rate increases. The impact on Singapore? I expect rates to hold steady... there's just no more justification to rise further... Given that the financial system is still flushed with funds, I expect rates to drift downwards.

Fixed rates are typically priced at higher rates than typical variable rate ones. That has always been the case. If one had chosen a fixed rate pacakage 2 years ago, he would be laughing to (at) the bank.. why? Because in a period of rising interest rates, he would have kept his rates at extremely low levels. However, the reverse also holds true. If one chooses to go "fixed" in a period when interest rates are falling, one could end up holding a VERY expensive mortgage.

So... how does one decide? Simple. Do your homework. Keep abreast of market expectations... then take a view. Decide what the interest rate trends are likely to be... then commit.

Don't be too influenced by what your friends say; they may not be well informed.

Think hard.

Good luck. :o)

(My little contribution to the community this National Day)


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