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.