The median mortgage interest rate is ready to double in as little as six months, and it looks like the era of cheap mortgages is coming to an end. Besides a predictable rush to HDB instead of bank loans (for those who can get them), this has implications for real estate investors, as well as genuine home buyers. Here’s how the rate hike could affect us in the years to come:
What happens to our cheap home loans?
The US Federal Reserve lowers interest rates, as a way to stimulate the economy in a downturn; it’s also driving rates down in Singapore, and Covid prompted that response.
However, we were seeing abnormally low rates long before Covid.
If you go back to the 1990s or early 2000s, mortgage interest rates in Singapore (from banks, not HDB) were often around 4%. This fell due to the global financial crisis in 2008/2009, following which the Fed set interest rates at zero.
At one point in 2011, (now defunct) SOR-based mortgages even saw negative interest rate.
The Fed tried to normalize interest rates back in 2018 – but then Covid hit, and the interest rate was again reduced to near zero.
Thus, the interest rate on real estate loans remained low for an excessively long period. Some borrowers haven’t seen rates above 2% since the early 2000s; and what was once a momentary boon has normalized.
However, nothing lasts forever – prolonged periods of low interest rates can drive up inflation, as it does in the United States. As such, rates are going back up and the old norm might be back to stay.
Although if you use HDB loans, none of this matters to you
The HDB concessional loan is indexed to our CPF rate, not market rates.
The HDB lending rate is still 0.1% higher than the prevailing CPF rate. Currently, the CPF rate is 2.5%, so your HDB loan is 2.6%.
That said, note that the HDB loan rate is not immune to change. If CPF were to increase the interest rate, your HDB loan rate would increase accordingly; but that hasn’t happened in over 20 years (as far as we know, the last time CPF changed the interest rate was in 1999).
How will all of this affect us in the future?
- Larger deposits to qualify for TDSR limits
- Landlords may be forced to raise rent
- The possible return of the semi-fixed as a strategy
- A preference for longer interest rate periods
- More innovative but complex loan formulas
1. Larger deposits to qualify for TDSR limits
The Total Debt Service Ratio (TDSR) limits your monthly loan repayments to 60% of the borrower’s combined income.
Currently, TDSR calculations already use an interest rate above the real market rate. It is 3.5%, regardless of the current rate.
For example, a $1 million loan over 25 years will have an estimated monthly repayment of around $5,000, at 3.5% per year. This would require a combined income of around $8,400 per month to qualify.
This practice has left borrowers well positioned to weather future rate hikes. However, as higher interest rates become the norm, we would expect the 3.5% “stress test” to eventually be raised.
For some borrowers, this could mean a larger down payment, to reduce monthly repayments to meet TDSR.
2. Landlords can be forced to increase the rent
Among homeowners who have defaulted on the loan, the usual expectation is that the rent will cover maintenance costs, as well as the interest component of the mortgage.
At the time of writing, rental rates are already on the rise, as foreign workers return. Given this opportunity, we think it’s likely that landlords will increase rent, expecting future rate hikes.
That said, rental rates are affected by many issues other than owner costs – so this assumes that other factors, such as the Russian-Ukrainian war, are not putting downward pressure on rental rates. .
3. The possible return of the semi-fixed as a strategy
This colloquially refers to a strategy where borrowers refinance from one fixed rate package to another. For example, taking a fixed five-year plan, then refinancing a fixed three-year plan at the end of it, and so on.
(There are no fixed rate perpetual loans in Singapore, so this is the best alternative to predictable repayments).
It wasn’t as popular in the last decade when interest rates were low and fixed rate plans tended to be expensive. However, borrowers seeking safety in a rising rate environment may return to it.
4. A preference for longer interest rate periods
Most home loan rates are pegged to one-month (1M) SORA rates or three-month (3M) SORA rates. This is the frequency at which monthly repayments are revised to match the current interest rate.
In a falling rate environment, 1M is preferred by borrowers – this is because you want repayments to fall as quickly as rates fall. In today’s rising rate environment, 3M will likely be preferred – even if the rate goes up, you’ll still be paying the previous three months’ lower rate.
Note that Nothing of the sort is secured, as interest rates fluctuate, and banks may charge a higher spread for 3-month loans than for 1-month loans. However, borrowers who want less volatility will always tend to opt for a longer interest rate period.
5. More innovative but complex loan formulas
Every time interest rates go up, banks start to innovate. A recent example is hybrid fixed and floating formulas, where half of the loan is variable and the other half is a fixed component.
In years past, we’ve also seen packages like interest-offset loans (where your interest rate on deposits is used to offset your mortgage rate).
It’s sort of a double-edged sword. On the one hand, it’s good to have options that could save you money. On the other hand, the calculations involved are a huge headache for the average borrower; and some of these loans are so complex that the terms and conditions are incomprehensible.
What about the impact on real estate prices?
This is where it gets tricky. Property prices move for a variety of reasons, of which mortgage rates only play one role; and you could say it’s a little part, in relation to factors such as waterproof housingor a flight to safety during downturns (which may well be the result of the current situation in Ukraine).
As we discussed before, most Singaporeans are in a good position to afford housing, even given rising interest rates. Keep in mind that the current projected rate is 3.5% for TDSR, and Singaporeans qualify even at these rates.
As such, we doubt that genuine home buyers will give up on their purchase, even with higher interest rates.
What is that could however, these are new investors who previously considered small real estate investments, such as buying and renting shoebox type units. The combination of higher ABSD and higher interest rates could make these small rental units less lucrative.
Borrowers using their CPF must review their mortgage situation
One of the risks of using CPF to service the home loan is that, at times, you become unaware of the impact of rate increases.
If you previously had a loan of $1 million over 25 years, at 1.3%, you would have paid around $3,900 per month. A one percentage point rate hike would increase to about $4,400 per month, a substantial increase of about $500.
It also risks reach the CPF withdrawal limit, and catch you off guard. The last thing you want is to wind down in your mid-fifties and then suddenly find you have to pay off the rest of your home loan in cash.
Now is a good time to reassess your home loan and finances, and talk to a mortgage broker about the future. Follow us on Stack so that we can keep you informed of the situation; we’ll also provide you with in-depth reviews of new and resale properties, so you can make the most informed decisions.