If you have been following the news closely, you would be aware that the US Federal Reserve has been increasing interest rates. It is one of the major levers the Feds use to adjust the economy. But how will it affect Singapore? Or are we immune to such effects?
I invite Ivan Ong, a mortgage specialist, to share some thoughts he has about the rising interest rate environment, and how that might affect Singaporean homeowners and decisions they may want to make on home loans.
This year, the Feds have hiked interest rates, most recently by 0.75% on Jul 27th, the second consecutive 0.75% hike in just one month. The rate now hovers between 2.25% to 2.5%, a far cry from Jan 2022 when interest rates were close to 0%.
Such moves will impact Singapore, a small open economy, in different ways. The most direct impact is our own interest rate. The Singapore Overnight Rate Average, or SORA, has gone up to 1.56% on 29 Jul, from just 0.14% at the start of the year, a nearly 10-fold increase. How will this impact the common man on the street?
In short, most people who have a loan will be affected. In particular, any person who has a home loan might feel the impact the most. As we pay interest on our loans, rising interest rates make our loans more expensive. Therefore, to understand what we should do, we first need to understand what will happen to the rates.
What is likely to happen to the rates?
First of all, SORA is expected to continue increasing over the remaining months of 2022 and the first half of 2023. This is in part due to the economic climate in the USA. Given the presence of high inflation in USA, it is likely that rates will continue to rise in order to fight inflation. The war in Ukraine and the supply crunch in China due to COVID do not help matters.
So does this mean we should lock in our rates for a long time since interest rates will continue to rise? Well, it is not that simple.
The economic challenges listed above could possibly lead to a recession. On top of that, the rising interest rates themselves could lead to negative growth and potentially push the economy into a recession. If that happens, interest rates are likely to fall since the countries will try to jumpstart the economy.
Even if we manage to avoid a recession, inflationary pressures could taper off in response to rising interest rates and economies adjust to the new climate.
In other words, the interest rates could go up, sideways, or down. It is highly unpredictable. However, you still need to pay off your loan. So, what can you do?
Let’s now understand the options available. Generally speaking, there are two types: The first is a floating rate, and the second is a fixed rate.
A floating rate is typically pegged to something like the 3M SORA, with a small spread. In this case, your interest rate will follow SORA movements closely. If the interest rate falls, you might celebrate because your monthly payments will likewise fall. But hold on: upward swings in interest rates also means your monthly payments go up.
A fixed-rate avoids all that drama. A fixed-rate loan is fixed and guaranteed for a few years, after which the loan converts to a floating rate, but you have the option to refinance after the fixed rate has expired. What you get is certainty for the first few years, and the peace of mind that nothing changes. However, this comes at a price.
Both types of rates have their strengths, and there are nuances between the conditions attached to each rate. A mortgage specialist can help you find the best deal, or forewarn you of certain conditions that might work against you.
Should we reduce our loan?
Finally, a word on “capital redemption”, or paying off a part of your loan. At the time of this article, CPF-OA interest rates remain higher than the interest rates of some packages. The projected rate of return on investments is also at levels that are comfortably higher than mortgage rates. This means that your money could be used to work harder elsewhere instead of paying off the loan. While capital redemption might mean a smaller loan, it limits your liquidity, since you are generally unable to unlock part of the value of your house.
However, to mitigate against the possibility of extreme rate hikes, it would be prudent to continue accumulating a sum of money that could be used to redeem the loan when necessary. The monies now can be deployed to different instruments to ensure they are readily available and provide you with liquidity and resources to take advantage of market movements.
Each person will have their own risk appetite as well as expectations of how the market will move. As a result, there is no one-size-fits-all approach. A conversation with your financial advisor will help you to decide what is better for your overall financial health, given your goals and resources.
A mortgage loan is (for most of us) the largest loan we will ever take. It often serves as our largest single liability. What matters most is that we do not get overly troubled by this liability, and ensure our financial health stays strong.
About the writer:
Ivan Ong is an independent Certified Financial Planner specialising in Mortgage Planning. His mission is to help clients leverage their property purchase without taking too much risk, and he works closely with other financial planners to serve clients holistically. Through him, clients can gain access to preferential rates from 16 banks without being charged a fee.