The Hong Kong Mortgage Corporation (HKMC) has recently introduced a pilot scheme for fixed-rate mortgages for 10, 15 and 20 years, with rates fixed at 2.55 per cent, 2.65 per cent and 2.75 per cent, respectively.

The maximum loan amount caps at HK$10 million (US$1.3 million). At the end of the fixed-rate period, the borrower may either re-fix the mortgage rate under the scheme, or convert to a floating-rate loan, which is equivalent to the prime rate minus 2.3 per cent. With the current prime rate at 5.25 per cent, the effective interest rate after the fixed-rate period would stand at 2.9 per cent.

Market observers criticise this and say that the new fixed-rate plan is more expensive than the Hong Kong Interbank Offered Rate (Hibor) linked plan, which renders the former unattractive. On the surface, this view has grounds.

As the Hibor rate now enters a downward cycle, H-plan currently hovers around 2 per cent and a drop is expected in the future. This is indeed much lower than the fixed rates of 2.55 per cent to 2.75 per cent advertised by HKMC.

To put things in perspective, for the average HK$4 million mortgage loan, choosing the H-plan will save between HK$1,124 and HK$1,545 monthly on repayments compared with the 10-year or 20-year fixed contract.

However, what if the Hibor rises subsequently? The H-plan rate actually includes a clause. If a borrowers’ repayments are greater than they would be on a prime rate-linked mortgage, they will be automatically switched to the prime-based payment scheme of P minus 2.75 per cent. That is equivalent to 2.5 per cent currently, still below the 2.55 per cent to 2.75 per cent of the fixed-rate plan.

Only if both the prime rate and the Hibor rate rise significantly will the fixed-rate plan start to gain traction. Furthermore, after the fixed-rate period, it will be converted to a floating rate of a whooping 2.9 per cent according to the current prime rate. This is a far cry from the current H-plan rate of 2.0 per cent.

To make things worse, the fixed-rate plan does not offer cash rebates nor a mortgage link account. Cash rebates for new mortgages now sit as high as 1.95 per cent of a loan amount. For a HK$4 million mortgage, it translates into a HK$78,000 rebate in the pocket of the borrower. Due to the higher mortgage rate and the infeasibility of a cash rebate, the fixed-rate plan does not seem to offer an attractive deal to borrowers.

Of course, no one has a crystal ball with which to predict changes in future rates. Black Swan events sometimes happen. In 2007, the prime rate increased to more than 7 per cent. Should history repeat itself in the next 10 to 20 years, then the fixed rate will win.

Barring any extreme events, there are still some situations where borrowers may need to consider opting for the fixed-rate plan. In this case, the devil is in the details of the HKMC plan.

Currently, for a property valued above HK$10 million, the maximum loan-to-value (LTV) ratio is only 50 per cent. Moreover, the borrower has to pass a stress test showing his or her ability to make repayments if the interest rate rises to 3 per cent.

However, the newly launched fixed-rate plan does not require borrowers to undergo the stress test. If a borrower’s debt to income ratio is below 50 per cent, the mortgage can be approved directly.

Let’s look at a practical example. One of my clients intends to purchase a flat valued at HK$20 million and intends to borrow HK$10 million (50 per cent of LTV, or 50 per cent of the flat price).

If she chooses the fixed-rate plan, the minimum monthly income requirement would be HK$79,546. However, if she chooses the Hibor plan, which requires the stress test, the minimum income requirement would rise to HK$94,632.

As her income is only HK$80,000, the fixed-rate plan would at least entitle her to secure a mortgage for her dream home. Otherwise, she may need to find a guarantor, or cough up a higher down payment. Even worse, she may need to compromise on buying a cheaper home.

However, for property valued under HK$10 million, borrowers will not face such a dilemma, because first-time buyers of these properties could secure 80 per cent to 90 per cent in LTV ratio without the need for a stress test, even if one chooses the H-plan.

Hence, that will put both Hibor and fixed-rate plans on the same level playing field when it comes to income requirements. In such a case, whether one should go for Hibor or fixed depends solely on one’s view of future interest rate movements.

The fixed-rate plan may also appeal to first-hand homeowners who have relied on developers’ financing in the past and now want to refinance the mortgage to banks. In the past, the standard mortgage ceiling for flats priced above HK$6 million was only 60 per cent. Hence, being unable to apply for adequate mortgages from banks, a spate of homebuyers had turned to developers’ financing, which can cover as much as 80 per cent or 85 per cent of a property’s value.

Home purchasers who signed up for developers financing schemes would repay less in monthly instalments, but this would increase after the holiday period of about two to three years. By that time, their financial burden would increase as interest rates rose.

Thanks to a relaxation in the mortgage ceiling in October last year, homeowners can now refinance their properties up to 80 per cent of their values (less than or equal to HK$10 million).

This enables homeowners to easily refinance their developers’ mortgage to bank mortgages and enjoy the low mortgage rates of the latter. The downside is to qualify for such refinancing, the borrower has to pass the stress test. Hence, for those who have insufficient income to pass the stress test, the fixed-rate plan, which does not require such a test, is the only way out.

Raymond Chong

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