interest rate hikes household debt

Recipe For Disaster? Potential Interest Rate Hikes Plus Rising Household Debt

I came across this article in The Straits Times saying that MAS is advising Singapore households on rising mortgage debt ahead of interest rate hikes. We have been enjoying relatively low-interest rates for more than 10 years and we should not assume that it will continue forever. We will take a look at how rising interest rates might affect household debts and property prices.

Disclaimer: The economy does not move only due to one or two factors as it is a piece of complicated machinery with many moving parts. We will look at how the economy will generally move should everything else stay constant.

All comments on this blog site are an expression of opinion. You are recommended to consult with a licensed, qualified financial advisor before making any financial decisions.

Potential Interest Rate Hike

We can expect prices to keep rising in the coming months. Food prices are expected to increase due to multiple factors like energy prices and supply chain bottlenecks. The private residential price index is also almost at an all-time high reaching 152 points in 2020 Q1.

Singapore’s overall inflation rose to 3.2%, an 8-year high in October 2021. US’s inflation jumped to 6.2% in the same month, the biggest rise in more than 30 years.

us inflation data

Source: StocksEra

The lastest inflation data for November 2021 is out and it is now 6.8%. It might be a coincidence but, when we last had such long periods of high inflation, it was during the 2008 financial crisis.

With the low-interest rates that we have enjoyed over 10 years, money is “cheap” so instead of saving it up, there is increased spending, bringing up prices. With increasing inflation, our money is also worth more now than later so there is less incentive to save it up.

In order to lower prices, one of the tools the central banks of the world are to increase interest rates. However, by doing this, loans become more expensive, spending decreases, affecting the economy and stock market negatively. Nobody wants to stop the bullish party that has gone on since the last financial crisis in 2008. Although we had a flash crash in March 2020 due to Covid, the market recovered quickly and is now at an all-time high. When the prices get too high for the public to tahan, it might signal an inevitable interest rate hike to bring down prices.

Singapore is the only major economy in the world to use exchange rates instead of interest rates for our monetary policy so we will not have much control over any potential interest rate hikes. Our interest rates are mainly determined by the movement of US interest rates and the future strength of the Singapore dollar. Whether there are any future interest rate hikes, the ball is not in Singapore’s court.

Rising Household Debt

Singapore household debt has increased both in absolute (6.8% over the past year) and relative terms (67.1% of GDP to 70% of GDP).

Household net worth is made up of four components

  • Financial Assets
  • Residential Property Assets
  • Personal Liabilities
  • Mortgage Liabilities

2021 q3 household liabilities

Source: Department of Statistics, Singapore

Out of the total household liabilities of S$353.8 billion, mortgage loans make up 71.4% of the pie while the other 28.6% is made up of personal loans like credit card and car loans.

household loan liabilities mortgage personal loan

Source: Department of Statistics, Singapore 

We can see that mortgage loans are increasing faster than personal loans.

household balance sheet asset liabilities

Source: Department of Statistics, Singapore 

Although asset values have been increasing faster than liabilities, if there is an interest rate hike, assets like stocks and property might fall in prices, lowering net asset values. Additionally, payments on floating-rate loans will also increase.

household balance sheet assets

Source: Department of Statistics, Singapore 

For assets, financial assets as a whole have increased faster than residential property assets but if we break down the financial assets into individual components, property assets make up about 42% of all assets, with the second-highest being cash at 20%.

From these charts, we can see that residential assets are a major cause of the increase in assets and liabilities.

Interest Rate Hikes And Household Debt

An interest rate hike will directly affect household debt, with mortgage loans taking up 71% of the pie. Loans on personal loans are generally fixed across the whole tenure so we will focus on home loans.

Home loans can be taken at either floating or fixed rates.

For floating rates, the rates will fluctuate according to the interest rate environment.

If you think that the interest rates will decrease in the future, a floating rate will be more advantageous. When the interest rates drop, the amount of interest payable will also drop accordingly.

For fixed rates, we will usually pay a promotional rate for the first few years (typically 2 – 3 years). When the promotional rate expires, the rate will go up significantly and it can be equal to or higher than the floating rate. Although it is a “fixed rate”, the interest is only fixed for a few years and not the entire tenure. We will then need to refinance at the new prevailing rates, choosing between a fixed or floating loan.

If you think that the interest rates will increase in the future, a fixed rate will be more advantageous. When interest rates go up, you will pay the contracted fixed rate until it expires.

Illustration

If there is an interest rate hike, it will increase the amount of interest to be paid regardless of whether you take a fixed or floating rate loan.

For every 1% increase in interest rates, we can expect monthly instalments to increase by 8 – 9% for the 2 – 4% range.

Loan Amount S$500,000
Loan Repayment Period 20 years
Interest Rate 2%
Monthly Instalment Amount S$2,529
Total Interest Paid S$107,083
Interest Rate 3%
Monthly Instalment Amount S$2,772 (increased by 9.6%)
Total Interest Paid S$165,604 (increased by 54.7%)
Interest Rate 4%
Monthly Instalment Amount S$3,029 (increased by 9.3%)
Total Interest Paid S$227,291 (increased by 37.2%)

We can see that the monthly instalments and total interest increase quite significantly from the increase in interest rates. An increase in interest rates can greatly affect the ability to pay off mortgage loans even if everything (income, employment status) stays constant.

Interest Rate Hikes And Property Prices

Interest rates can affect property prices via the cost of capital for developing and purchasing and the present value of the property via the discounted cash flow method.

private residential price index vs 3 month sibor sora

Source: Date from MAS and Data.gov.sg

I won’t pretend to know how exactly interest rates will affect property prices but if we look at the data from 1987 Q3 to 2020 Q1, the private residential price index and the 3-month average SIBOR/SORA have an inverse relationship to a certain extent. The correlation between the two values across the years is -0.73766. 1 is a perfect positive correlation and -1 is a perfect negative correlation.

So if there is an interest rate hike, the probability of property prices dropping is not low.

It will be a double whammy when property prices fall together with the increase in interest paid. For example, we will need to service a S$500,000 loan even when the property price has fallen to S$450,000 (assuming a 100% loan is taken for illustrative purposes).

The Sure Winner Of Property Investment Is Not You

Property investing in Singapore has been believed to be a safe and prudent investment due to reasons like various reasons like

  • Limited land space
  • Leverage increases returns
  • Physical asset
  • Rentable
  • Prices are in a rising trend

From 1975 to 1995, every S$1 invested in private properties became S$10 over 20 years while every S$1 invested in the stock market only became S$7 over the same time frame.

However, from 1995 to 2021, every S$1 invested in private property grew to S$1.30 while the same dollar grew to about S$7 in the stock market.

Investing in private property is also a huge commitment unless you are Mr. Musk or Bezos. Most of us will only buy one property, at most two, at a time. You better make sure you buy the right property at the right price and sell at the right time.

A report from UrbanZoom showed that the average Singapore condo has a lower yield than if you have just left it in your CPF Ordinary Account at 2%.

The real winners are the middle man.

I remember being blasted by ads with overly-enthusiastic salespeople on tv by 99.co and Propnex mid this year, promoting their webinars and platforms with expert insights on real estate investments.

These companies make money regardless of the market, either via ads on their listing platforms or from commissions from either buying or selling. Read about sale tactics that salespeople use to influence customer behaviour here.

Don’t Ask A Barber If You Need A Haircut

Getting an investment property is a huge commitment. How many 20 – 30 years do we have in our lifespan to service that mortgage loan? Do your own homework on top of talking to a property agent and see if you can or should get involved in property investments. There are a lot of resources online that you can refer to and forums you can read and ask questions. No one else besides yourself has the most skin in the game should you decide to invest.

A few years ago, I saw a huge banner ad plastered at a bus interchange stating that you can own two private properties (stay in one and rent out the other) after selling your public HDB flat. MAS has advised that buyers should be aware of the long-term commitments and the huge capital outlay before committing to such a huge investment.

There are many variables like a drop in property prices, forcing you to continue servicing the loan of a loss-making property or a change in employment status, resulting in a potential decrease in cash flow to service the loans. Your yield is also directly impacted if there are periods you can’t find a tenant or you have to perform maintenance on the property.

You don’t have to invest in a physical property if you want exposure to that asset class. We can also invest in REITs that hold a basket of properties and are managed by a team of professionals. The cash outlay and effort to take care of the property is much lower via REIT investing.

Don’t get caught when you just look at potential returns without accounting for a potential hike in interest rates and other hidden costs with owning a property.

TL, DR

MAS has advised that a potential interest rate hike will affect rising mortgage debts. Inflation rates have been high, prices are rising. Interest rates rising is one of the tools to bring down prices. When the interest rate rises, it will affect the monthly instalments and total interest paid for residential loans, which makes up 71% of a household’s liability. Do your homework and make sure that property investment is suitable for you and not just rely on what property agents say.

I am writing from a perspective of an outsider as I do not own any property. If there are any wrong calculations or assumptions made, do let me know.

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