Of the many benefits one gains having being in the home loan industry for many years, one in particular is a clear insight into how people think when choosing a home loan. Many factors are in play but none as influential as the “interest rate” of the loan, usually taken as the indicator of the cost of the loan and hence a borrower’s ability to afford the said loan.

However, the true cost of a loan is often mistaken simply because the interest rate or cost of the loan consists of 2 separate components, one of which is constant and the other a variable, and it is the variable that is often overlooked.

Interest Rate = Base Lending Rate (BLR) + Spread (a.k.a. Margin)

Whilst a lending bank will usually define and fix the loan’s spread e.g + 1% or -2%, the other component which is equally if not more important, is the Base Lending Rate which is truly a factor beyond anyone’s prediction especially over a long term such as the loan’s 25-30 year tenure.

For most of us, the author not excluded, it is best for us not pretend to understand the “invisible forces” that make the BLR go up or down. It is often said in jest that when the US Treasury sneezes, the rest of the world catches pneumonia. Whilst it may have been said as a joke, what is certain is that Malaysia’s BLR is something that moves in response to a number of internal and external forces, none of which are within the loan borrower’s control. Imagine that! You have no control over what may be the single largest debt you own.

So, if the interest rate of a loan is so important to the borrower (to the extent that a mere 0.1% difference is adequate to swing a borrower’s decision from one lender to another) shouldn’t we make an effort to understand this variable called BLR. Afterall. This is one factor that can have such an impact on one’s continuing ability to afford the loan over its entire tenure, not just in the initial “honeymoon” years.

Much can be learned about BLR from just looking at the BLR chart below.

Let us examine what we can learn from the chart.

Observation 1.

BLR is NOT a constant and it changes in response to internal/external economic influences. Therefore, if a loan you are planning on taking is a BLR-based loan, you must accept the fact that the cost of the loan that you decided you can afford when you signed on the dotted line, may not be the cost you will be obliged to pay in future.

Taking the “cheapest” BLR-based loan available in the market today, a mere 1% average increase in BLR over the tenure of the loan will see to it that the borrower pays about RM40,000 more in interest [ read-RM40,000 more in cost]. Dare we postulate a 4% or 5% increase, or is it cozier to stay in denial?

Observation 2. 

How high can BLR go? Well, if BLR prediction were a sport, it must surely rank somewhere between darts and mumblety-peg. Sometimes the sharp end bounces back. But seriously, BLR as the chart indicates has spiked to almost 13% twice in the last 25 years (coincidentally the favorite tenure of loans) with the most marked increase being in January 1995 from a base of 6.6%, to a high of 12.27% in June 1998.

To put it into perspective, if you had taken a RM225,000 loan in January 1995 and signed on to pay approximately RM1531 per month, you would be paying about RM2,400 for the same loan three years later. Of course to assist you the bank may allow you to maintain the same monthly repayment but you will end up paying for many more years that anticipated., and ultimately at a much higher cost than you thought when accepting the loan in 1995.

A bank’s letter of offer today states that the bank’s BLR is 6.75% presently which gives the illusion that the rate is fixed. It is not and one must remember that the loan’s overall interest rate is ultimately determined by BLR which can be a highly strung kid tripping on sugar.

And we might as well now correct a very popular misconception. As competition amongst lenders become fiercer over the recent years lenders have indeed slashed their spread or margin which gives the impression that interest rates are southward bound. Remember the loan’s interest rate is a function of BLR + Spread. BLR so happens to be on the upward trend rising from 6% to 6.75% over the last two years. Again, any discussion of rates going up or down is mere conjecture and a borrower should look at the loan being taken over a 25-30 year horizon.

Observation 3.  

They say life is about timing but in reality a lot of good opportunities become lost waiting for “perfect conditions”. A BLR based loan would be great to have when BLR does nose-dives but is that where we are at now?

When the base rate hit an all-time low of 6% in 2003, lending became so cheap that along came a number of loans FIXED at ridiculously low interest rates. Fixed rate loan as the name suggests are unlike BLR-based loans in that there is no BLR influence and as such the interest rate, ie cost of the loan is fixed from the beginning.

Fixed rate loans today are offered by a number of Insurance Companies through their mortgage departments, as well as a host of Islamic Banks. Fixed rate loans on offer range from 5.75% with some lock-in period to 7.25% without any lock-in (no penalty for early settlement). There are even some “hybrids” i.e. BLR-based loans with rates capped at a maximum rate of 7%-8%.
Translated, with these loans, you KNOW how much you are going to pay and you never have to pay a cent more regardless of what economic cycles we are in. Having the certainty and peace of mind? Now that’s really good value. The bonus is, these loans are fixed at a rate lowest in history.

However, it is not a mystery why fixed rate loan uptake is still a low percentage of the overall industry loan growth. Put a BLR-2% loan (at  6.75%, BLR-2% = 4.75%) beside a loan fixed at 5.75% and the untrained eye would say the BLR-based loan is cheaper, and it may very well be the case but for the fact that BLR fluctuates and presently seems to be fluctuating upwards.

Cosmetics have become very important in packaging loans and this is where the fixed rate loans can look like pumpkins beside a Prada-clad  loan with rates of 2.5% in year 1, BLR+0% in Year 2 and BLR plus or minus spread for subsequent years. Remember the highly strung kid on a sugar hit? He is wearing Prada (with apologies to fans of The Devil Wears Prada).

In conclusion, as you debate between Lender 1 with rates at BLR-2% with 5 year lock-in and compulsory MRTA and Lender 2 with rates at BLR-1.6% with 3 year lock-in, and no MRTA and Lender 3 at 0% in the first year followed by BLR+0% in subsequent years and Lender 4 with rates of BLR-0.5% Flexi and Zero Entry Cost and Lender 5 with that free 42” Plasma TV…..throw into the equation, another factor. Ask yourself how much BLR increase can you really afford?

Having said all that, the case must be made for BLR-based loans with flexi features that allows you to offset monies kept in deposit against a corresponding sum of the loan’s interest. BUT, be sure that you have the said “monies in deposit” for the interest-offset effect to happen, and all the big money you are going to win from your friends at the next World Cup when Paraguay beats Argentine shouldn’t count in your analysis.

For now, smart money is on the lowest fixed rate in history. Some fixed rate loan providers will absorb your entry costs (ZEC packages) and may even be convinced to throw in a couple of Prada bags to carry your worries away.