To Hedge That Housing Loan ?
It is great to be rich, and 99.9% of the world agrees with me, I know. But it does come with consequences.
For a typical 1 mio dollar housing loan, deciding between 3 year fixed rate loan of 1.8% against the floating rate loan of 0.8% is about 10k a year. Take that and multiply it by 5 for a 5 million dollar loan that a friend of mine has and it becomes 50k which can cause more sleepless nights even if we assume that it is loose change for someone with a 5 million dollar loan.
That is the dilemma a friend of mine had recently in deciding whether to hedge his housing loan.
He was deciding in whether to put on a 5 year interest rate swap at 1.6% to pay a fixed rate and receive a floating rate that would be used to service his floating rate loan. That difference worked out to be just about 65k per annum in interest difference, to his disadvantage.
Why would anyone want to take a fixed rate loan or hedge their existing loan on such poor terms ?
The answer is that no one would.
6 month SOR has been stuck at 0.3% for the past 6 months. Moving a mountain would be easier than bringing it up to 1.6% and even if it happened in year 2, the 65k loss for year 1 would have been incurred. Even if the 5 year interest rate rose abruptly immediately after the deal, we would need a 0.15-0.2% move up to 1.80% to make up for the realised interest loss.
Let’s assume that Singapore rates mirror the US’s rates. Using the 3 month Eurodollar contract i.e. 3M Libor rate at the date of the settlement in Mar, Jun, Sep and Dec. The Eurodollar is an important contract because it is a reflection of market expectations of rate hikes.
As we can see, the first rate hike is not expected until mid next year.
Table : Eurodollar implied rates for 3m Libor (for illustration purposes only)
3m Libor | 3Y rate | 5Y rate | |
18-Jun-14 | 0.23 | 1.06 | 1.89 |
17-Sep-14 | 0.24 | 1.26 | 2.07 |
17-Dec-14 | 0.27 | 1.47 | 2.25 |
18-Mar-15 | 0.36 | 1.7 | 2.43 |
17-Jun-15 | 0.53 | 1.93 | 2.61 |
16-Sep-15 | 0.76 | 2.16 | 2.79 |
16-Dec-15 | 1.01 | 2.37 | 2.96 |
16-Mar-16 | 1.28 | 2.58 | 3.11 |
15-Jun-16 | 1.56 | 2.77 | 3.26 |
21-Sep-16 | 1.85 | 2.96 | 3.40 |
21-Dec-16 | 2.12 | 3.12 | 3.52 |
15-Mar-17 | 2.34 | 3.26 | 3.63 |
21-Jun-17 | 2.56 | 3.4 | 3.73 |
My friend would have to wait till mid 2016 before his hedge at 1.60% made sense. During the period, he would have lost 65k for the first year and another 36k for the second year.
After that, assuming all goes as planned, he would save about 20k for the third year and even if the rate stays at 2.5% after year 3, the savings would be about 50k per year thereafter. I think it works out to be a small profit ?
By then, he could also sell off his interest rate swap at the 3Y (5y minus 2y = 3y) rate of 2.77% which would net him a profit of about 175k to cover his initial loss and future losses of paying the 2.5% 3M Libor rate.
The scenario is different if you commit to a fixed rate home loan of say 2.18% for 5 years because you do not have the option of taking profit.
Nonetheless it will turn profitable after year 2 using the rates illustrated in the table above and a point to consider would be that the rates above do not include the credit margin/spread that your bank would charge you.
Some of my other friends who constantly badger me on where I think the Sibor is headed are of the mindset that as long as the interest rate difference between their floating rate and the fixed rate is about 1% ie. 10k per mio, they are not going to budge from the floating rate option. Afterall, the last time 3M Sibor was at 2.5% was back in 2007 and the world has changed since.
Yet if they were to wait until the difference starts narrowing, the fixed rate option is likely to be higher for them. But I am not about to take on their common sense for a heated debate, because, after all these years, I have to admit that SIBOR still does not make sense to me.
Too expensive to hedge, too expensive not to hedge. The steepness of the curve is a pity for over leveraged Singaporeans they better hope the curve is wrong, because if its right those familes where the husband works and the wife works will soon need to send the kids out to work too.
Go for the cheapest short term option.
I’m on 3M Sibor + 0.8% *forever*, so will stick with it (for now).
I think most Singaporeans are on the same thing.
The current US curve implies that US Libor will rise by over 300bp by late 2018. In other words, Libor should be a little under 4% in a few years from now, according to the curve. If we use history as a guide then that would suggest Sibor will then be in the region of 2.5%….these are of course highly approximate ball park figures based on a beta of 0.6 ish. So the current 1% (ball park) annual cost of a typical mortgage at Sibor + spread then becomes something in excess of 3% per annum. How painful will a trebling of monthly mortgage payments be for the average Singaporean? Very painful I would guess, given most Singaporean families are already stretched. And as Singapore has no interest rate policy, just an FX policy, there is very little the MAS will be able to do to help. No wonder the property boom seems to be all over. Funnily, during the boom the prices rises were applauded, as if they were somehow putting Singapore on the global map as a rich world class city. But in time I believe Singaporeans will come to see the boom as having been more of a curse.
I just saw on CNBC or somewhere that nobody really believes that rates will rise that quickly so 2015 may be a long shot away in everyone’s minds.
Afterall, just 1 year ago, economists and strategists were all predicting the first hike this year too and we are halfway into 2014 and nothing is happening.
Singapore changed her approach some time back. FX policy is one aspect, the other little known operation is now known as liquidity management operations which means WE DO HAVE AN INTEREST RATE POLICY !???
I don’t see them allowing rates to go up yet.. not with the elections around the corner.
No, Singapore targets it’s exchange rate, not its interest rate. It’s liquidity management operations are to implement its exchange rate policy and ensure the banking system operates smoothly. If the interest rates in the basket of currencies it manages it’s currency against go up then interest rates in Singapore will also go up. Of these the USD is highly influential, obviously. The reason there is no interest rate policy target rate is that interest rate parity forces a choice as to what to target and having targeted FX the MAS can’t then target interest rates. When US policy rates are hiked, Singapore rates will go up too. Basic finance, sorry. The MAS website explains all of this.
Then, in no uncertain terms, floating SIBOR loans are screwed !
I like to think that MAS can do a little more in their liquidity management operations than throwing our lot in with the US.
But after all these years, I find that I really do not know much about SGD Sibor or how it is priced anymore.
impossible trinity suggests you need to forgo free capital mobility if you want to manage fx and interest rates…so yea SG rates wld undoubtedly follow US rates whereever it may go..on sibor rates, they seem to follow the MAS bills closely and there are fx & liquidity considerations to these rates eod
Sounds too airy for me. Thought interest rates were supposed to be based on things like inflation and stuff.
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