The illusion of lower interest in tiered mortgages: Does a lower interest rate always mean the best?

Bank 1 :
1-3 years : Fixed 4.15
Thereafter : BLR - 1.9

Bank 2 : 
BLR-2.25 whole tenure

Bank 3:
1-3 years : fixed 4.4
Thereafter: BLR - 2.30

Which one is the best?

Which package does make more sense for loan applicants? Most of us, without a shadow of doubt, Bank 3 seemed to offer the most competitive package among all of the three as the remaining tenure after 3 yrs is the lowest among them. However, underneath a lower interest rate, there is a common trick that used by majority of bank, in which, I would like to name it as "The illusion of lower interest rate in tiered mortgages". 

Let us make it numerical. Consider we borrow 100k from each of the banks with a tenure of 30 yrs. An important point which put into consideration - The movement of BLR. Throughout the past 20 yrs, average of BLR is standing around 8.1%. To be conservative, we make an assumption that by the end of tenure, the BLR is expected to stand at 8.1%.

We all expect that the package that we choose is going to make us better off, whereby, we pay less interest to the banks. Based on the information over here, outcome of computation should be:

Bank 1 package:
Interest paid: 88,485, Monthly installment: 486

Bank 2 package:
Interest paid: 87,242, Monthly installment: 480

Bank 3 package:
Interest paid: 89,346, Monthly installment: 501

If you are a cost saver rather than a lower-rate seeker, your option should be (2) instead of (3). You might be surprised by the outcome as for (3), 27 yrs of lower variable rate should be far more superior than the others (this is our common belief). However, banks' product designers are not the guys who getting the pay and do nothing. The concept of fixing the rate over the 1st 3 years is indeed a profit generating machine of the banks. Bankers will always try to promote these kind of packages by telling the applicants that these kind of packages can hedge against the rising BLR (but don't forget they are also securing the profitability of a loan as well, if you are determined to hedge against rising BLR, just go for fixed rate for whole tenure). Our amortization methodology that used in the mortgage implied that a big piece of our 1st 5~8 years of monthly installment will be used to serve interest instead of knocking principle. With fixing a rate higher than current effective interest rate during the 1st few years, it will cause the applicants to service more interest (thus, banks earn more) while to comfort you, banks just let go some portion of interest in the future time (ie. BLR -2.3% for the remaining 27 yrs)

The expectation & actual BLR movement plays a significant role in determining the actual interest cost for the packages. Preference of package can be built up on the expectation of WHAT IS THE BLR MOVEMENT IN THE NEXT 3 YRS: (current BLR at 6.3%)

If BLR does not go beyond 6.4% , choice should be:
2>1>3
If BLR goes beyond 6.4% but <6.9%, choice should be:
2=1 , >3
If BLR goes beyond 6.9%, 
3>2>1

Expectation is almost everything. Throughout the past 10 yrs, historical peak of BLR is around 6.75%, however, if a similar crisis like 1997 is going to happen again, we can expect for average BLR = 8.1% (average of past 20 yrs). Normally for a full tenure calculation, we are going to take the increment will soon reach 8.1 % in the next 30 yrs time as the uncertainty of economy performance is indeed very high when you talk about 30 yrs. Who know what is going to happen in the next 30 yrs or next 10950 days? We just can prepare for the worst and pray for the best.

So, do you think banks just have a price war and keep on pressing down their rate and slicing their profit margin? Well...think again.



Do you know that 50%~80% of your monthly installments during the 1st half of your tenure is just to service the interest of a mortgage loan. While 65% of the total interest payable had been serviced during the 1st half of your tenure?

Choosing a fixed rate package for the 1st few years is just like a betting game, if you win the bet, you save more interest. For banks, it is just a matter of numbers as they can offer 2 inverse effect packages and let the public to choose. No matter what is going to happen, banks still the winner (of money) while the guys who bet wrongly suffer. A cruel truth to bear with. Ask yourself, are you prepare for it?