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Interest rates – and home loans – are on the up in 2022. This has been the function of central bank around the world increasing interest rate in a bid to curb rising inflation.
To get a sense of how much inflation is rising, we need only look at the latest inflation numbers for June 2022. In Singapore, inflation hit 13-year highs – rising 4.4%. While in the U.S., inflation has risen at the fastest pace in nearly 40-year at 9.1%.
The U.S. Federal Reserve Has Increased Interest Rates By Over 2% In Just 4 Months
Since Singapore is a small and open economy, and our only monetary policy is centred on exchange rates, interest rates in Singapore is determined by global interest rates condition. In this regard, the U.S. Federal Reserve is a major determinant of interest rates directions in Singapore.
In the span of the last four months, the U.S. Federal Reserve has increased interest rates from 0%-0.25% (in March 2022) to 2.25%-2.50% (in July 2022). This has been an unprecedented pace of interest rate adjustments. Broadly looking at the situation, we may not be at the end of escalating interest rates either. The latest interest rate hike on 27 July 2022 was for 75 basis points – the largest rate hike in nearly 30 years. This signified an acceleration in interest rate hikes rather than a slow down.
In total, there have been four rate hikes in 2022, and we can perhaps expect even more.
Source: U.S. Federal Reserve
Interest Rates In Singapore Are Already Higher, And May Go Higher
Prior to the recent interest rate hikes since March 2022, many of us may have been accustomed to seeing interest rates on our home loan package hover below the 1.5%-mark. All that has changed.
Recently, news broke that DBS had raised rates on all its home loan packages and scrapped its 5-year fixed rate HDB package. This was one of the longest fixed rate home loans in Singapore, and just goes to show that banks foresee rates continuing its upward trajectory.
We can also go on various home loan comparison website to check current interest rates. For example, on PropertyGuru Finance, we can compare over 140 private home loan rates.
From our search, the cheapest 2-year fixed rate package in the market today is 2.75%. After the two- to three-year fixed-term, we either have to refinance or reprice our home loan package or pay the floating rate.
Source: PropertyGuru Finance
Of course, we can also take a floating rate home loan package to begin with. These typically start out cheaper, but we bear some risks that interest rates may spike up (as it has done).
Again, on PropertyGuru Finance, the cheapest floating rate package works out to about 1.68% in the first year. However, one thing we have to bear in mind for floating rate packages is that the interest rate we pay typically goes up in subsequent years – even if interest rates stay exactly the same.
For example, Singapura Finance offers a floating home package charging us PLR19 – 2.07%. PLR19 is an internal board rate. We could not find any more information on what PLR19 refers to, so that’s another thing we need to take note with internal board rates.
Currently, PLR19 – 2.07% works out to the 1.68%. For what it’s worth, this means PLR19 is currently 3.75%. If interest rates rise, PLR19 (regardless of how its derived) will rise as well. Thus, we will end up paying a higher interest rate under such a home loan almost immediately. Similarly, if interest rates fall, we would also be paying a lower interest rate on the home loan almost immediately.
As mentioned, even if interest rates and PLR19 does not rise, we can see that we have to pay a higher interest rate in Year 2 – which is PLR19 – 1.87%. Similarly, in subsequent years, the interest rates we pay continue increasing (even if there is no change in the interest rate levels in the market).
This is not entirely unexpected as financial institutions typically offer a better interest rate at the start to attract us to take a home loan package with them.
Source: PropertyGuru Finance
Given that the latest interest 0.75 basis point rate hike by the U.S. Federal Reserve was the largest in close to 30 years, there’s every chance interest rates continue to rise.
What Happens To Our Home Loan If Interest Rates Rise By 1%?
In essence, when interest rates rise, the biggest concern for home buyers and home owners will be that home loans become more expensive. While the amount we borrow stays the same, even a few percentage points increase in interest rates can snowball into a huge difference, especially since most home loans span over 20 to 30 years.
Let’s take the example of a $1.35 million home. The maximum we can borrow is 75% of the property price – or about $1 million. Let’s see what happens when interest rates rise by 1%. Of course, even if interest rates increase, the total amount we owe does not change.
On PropertyGuru Finance, we can use a mortgage calculator to estimate our monthly repayments. For a $1 million home loan at 2% interest rate, our repayment is $3,696 a month or $44,352 a year.
We can hit the option to “See Full Repayment Schedule”. There we will be able to look at a detailed breakdown for our home loan. If we just concentrated on the “Interest Repayment” column, we can calculate that over our 30-year home loan period, our total interest repayment amounts to $330,600.
Source: PropertyGuru Finance
If our home loan interest rate increases 1%, we can simply do the same calculation using a 3% interest rate. Inputting the new figure, we can already see that our monthly repayment is $4,216 a month or $50,592 a year. This is about $520 more each month or $6,240 more each year. This is a substantial sum of money (to us at least).
Over the course of our 30-year home loan, we will be paying $517,700 in just interest. This is $187,100 more even though interest rates only went up by 1%.
Source: PropertyGuru Finance
Besides having to pay more for your home loan, home buyers will also be affected by the Total Debt Servicing Ratio (TDSR) when interest rates increase.
As we’ve already seen, an increase in home loan rates will translate to a higher monthly home loan. In turn, this can affect our ability to afford a home. This may force us into buying a less costly home or having to fork out a bigger downpayment for our home purchase.
Even though the TDSR does not affect most existing home owners, the higher interest still translates to a lot more money being paid in interest over our home loan.
What Should We Do When Interest Rates Are Rising?
Those buying a home may want to choose a fixed home loan to limit our exposure to the uncertain rate hike environment. Of course, we must consider current interest rates – which are already up about 2%.
On the other hand, if we believe the rate hike is at the tail-end, we could opt for a floating rate package – which may give us a more affordable home loan in the near future.
For existing home owners on a fixed home loan package, we do not have to worry about anything…yet. When our fixed-term ends, usually in 2 to 3 years depending on how long ago we took our home loan, we have to either reprice or refinance our home loan package. Eventually, the higher interest rate environment will still bite us.
For home owners on floating rate packages, most of you may have already received notifications from your bank telling you that your mortgage rate is going up. You can consider refinancing or repricing your home loan to a fixed rate package for greater interest rate certainty. Of course, you need to take into consideration the administrative costs that you must pay when refinancing and repricing. Again, if you believe interest rates will taper in the near future, then you can stay put on your floating rate package.
For existing home owners, we can also tap on smart solutions to minimise our home loan repayments. For example, on PropertyGuru Finance, we can check our ability to refinance within just two minutes. It will advise whether refinancing now or later makes greater financial sense for us. PropertyGuru Finance’s free SmartRefi platform will also tell us exactly how much it will cost to refinance our home loan, so we never have any doubts along the way.
Even if it’s not the best time for us to refinance our home, SmartRefi will nudge us at the right time, so we never end up paying more than we have to. What’s even better is that we can arrange for a personal consultation with a Mortgage Expert from PropertyGuru Finance to answer our questions and help us choose the best property loan.
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