Fixed Rate vs Variable Rate Mortgages

A key consideration before finalising your housing loan agreement with a bank is the interest rate, given the substantial amount of money involved and the long repayment period spanning decades.

In terms of interest rates, there are generally two types of mortgages, namely fixed rates and floating rates.

The major distinction between the two is that the interest rate of the first one remains unchanged through the entire life of the loan, while the second can rise and fall depending on the movement of certain financial benchmarks.

However, selecting which kind of mortgage to apply for is a challenging task for most people, especially for those without any background in finance.

So to provide borrowers with more clarity about these two categories of housing loans, PropertyGuru Malaysia has crafted a simple guide to help them determine which type would suit their needs.

As stated above, the interest rate of a fixed rate housing loan remains the same throughout its tenure.

This means if you took out a mortgage with an interest rate of 4.6% per year, your outstanding principal will only be charged at that rate.

In contrast, the interest rate may change for a floating rate loan, which is also known as variable rate or adjustable rate mortgage (ARM).

In Malaysia, this type of loan is pegged on the Base Rate (BR), while mortgages approved before 2 January 2015 are still based on the Base Lending Rate (BLR).

Under the old regime established in 1983, your effective lending rate is equal to the BLR plus or minus a certain percentage.

Notably, the BLR is an aggregate interest rate that takes into account a bank’s credit risk, profit margin, operating cost, liquidity risk, Statutory Reserve Requirement (SRR) and the benchmark cost of funds.

However, this system is considered opaque as borrowers find it hard to get a breakdown of each factor and compare it against the rate of other banks.

In contrast, the new system is considered more transparent as the BR only comprises the benchmark plus a certain percentage to ensure that the lender fully complies with the SRR, while the other factors are bundled up separately as a spread added on top of the BR.

With this setup, borrowers can compare not only the effective lending rate but also the base rate and spread of different financial institutions.

Please note that most Malaysian banks use the 3-month Kuala Lumpur Interbank Offered Rate (KLIBOR) as the benchmark for their BR.

A few others depend on a composite funding cost approach, which reflects the average cost of raising new funds through a variety of financial instruments like retail deposits and wholesale funding.

Borrowers usually apply for floating rate mortgages rather than fixed rates as the interest rate of the former is generally lower than the latter.

For instance, the fixed rate loan offered by AIA currently charges an interest rate of 4.99% per year, while one can get an adjustable rate mortgage for as low as 4.45%.

The disparity between the two loans is no small change as the total interest for the fixed rate loan during the first year is RM19,960, while that for the variable rate only amounts to RM17,800.

This shows that a difference of merely 54 basis points is equivalent to RM2,160 in additional interest payments.

However, if the benchmarks used on the BR like the 3-month KLIBOR were to rise during the loan’s term, it’s the borrowers who took out a variable rate mortgage who would be paying a greater interest.

For example, if the sum of the Base Rate and the spread were to hit 6.0% due to a hike in the 3-month KLIBOR, those who obtained a floating rate loan would be paying RM 24,000 in interest for the first year of the loan.

Despite their difference, there is no sure way to tell which of the two is the better option unless you have a friend who can precisely forecast the future trajectory of the 3-month KLIBOR.

Nevertheless, fixed rate loans are more advisable for borrowers with inflexible income and those with salaries that are unlikely to rise significantly during the term of the mortgage as the unchanging monthly instalments allows them to plan ahead.

While it’s difficult to create a long-term financial plan with variable rate mortgage, this type of loan usually come with many perks like redraw and overdraft facilities that can be of help when you sorely need cash.

In comparison, housing loans granted by ‘non-bank’ institutions generally don’t come with these features.

Lastly, ‘non-bank’ institutions usually require borrowers of fixed rate mortgages to sign up for a full Mortgage Reducing Term Assurance (MRTA) or some kind of insurance that will help pay for the remaining amount owed just in case the borrower dies or becomes unable to work before he has repaid the full loan amount.

While banks also require borrowers of floating rate mortgages to subscribe to such policy, they are usually relatively lenient with the terms. For example, they may just ask you to sign up for a basic plan.