4 things home owners need to watch out for as home loan rates go up

Homeowners in Singapore have been used to bank loan interest rates within the sub-2 per cent range over the last two decades. For almost 20 years, bank loan interest rates were lower than the interest rate for HDB housing loan, which is pegged at 0.1 per cent above the prevailing CPF Ordinary Account interest rate.

The extended period of low interest rates was perhaps the main reason driving demand in Singapore's property market.

Banks across Singapore have now raised their interest rates, most notably for fixed interest rate bank loan packages. Could this be the end of the era of cheap property financing? Well, we can’t predict the future. But what we do know is that, regardless of the situation, there are always ways for us to prepare against the impact of rising interest rates.

1. Add more buffer to mortgage savings for a rainy day

Homeowners are often advised to set aside some rainy day funds for your mortgage. This is because, in the event that interest rates go up, you will be making more monthly repayment on your bank loan. Therefore, you will always need to set aside some rainy day funds for your mortgage. You don’t want to end up losing the roof over your head.

With interest rates on an uptrend, this means that homeowners (or potential ones) need to add more buffer into your mortgage savings. Having more buffer gives you more flexibility to decide on your next mortgage move.

You can choose to delay refinancing to wait out the sudden spike in interest rates, or you can pay off a lump sum to reduce your monthly interest repayment. Even if interest rates continue to go up, you don’t have to worry about not being able to meet your monthly mortgage repayment.

As a general rule of thumb, 6 to 12 months of monthly repayment is a good buffer. However, in the current situation of rising interest rates, it might make sense to raise that to 18 months or more to give you a good level of comfort.

2. Is HDB housing loan going to be more attractive than bank loan soon?

The age old question of whether HDB housing loan is better than bank loan is bound to resurface. Already, some fixed rates offered by banks are higher than the HDB housing loan interest rate.

If you check out some of the latest interest rates on floating rate bank loan, they are still way below the 2.6 per cent interest rate that HDB housing loan is charging. For instance, OCBC’s three-month SORA pegged bank loan is at around 1.79 per cent on a three-year average. You will find a similar rate for DBS and Standard Chartered three-month SORA pegged bank loan at 1.84 per cent on a three-year average.

(As of this writing on July 20, 2022, 3M SORA is at 1.0877 per cent)

Simple math calculations will tell you that you can still save more currently by choosing floating rate bank loans over an HDB housing loan. However, beyond the next two - three years, it is anyone’s guess on how interest rates will change.

It will depend on how well central banks are able to manipulate interest rates to prevent the inflation rate from going out of control. But for the near future, taking up a floating rate bank loan while they are still about 1 per cent below the HDB housing loan interest rate makes sense.

ALSO READ: 5 key consequences of rising mortgage rates in 2022

3. Floating, fixed, or perhaps hybrid interest rate?

Choosing between floating or fixed interest rate is the other big dilemma for homeowners besides choosing between HDB housing loan and bank loan. As mentioned earlier, floating interest rate is still relatively low compared to fixed interest rate.

When it comes to fixed interest rate bank loans, banks often pack it with a significant margin of safety. That’s because they need to put in risk management measures to avoid making a loss in the event interest rates go north. This explains why fixed rates are almost twice as much as floating rates. With fixed rates, you are paying a premium for the security of knowing that your rates won't change for the first few years.

So if you prefer the stability and certainty of a fixed rate bank loan, you might want to consider a new “innovation” from DBS, i.e. the hybrid interest rate. DBS’ hybrid interest rate approach lets you mix it up between floating interest rate and fixed interest rate here you can park a portion of the loan under the fixed rate bank loan package. The remainder of the loan can go under the floating rate loan package.

Hybrid packages are meant to give you the certainty of a fixed rate bank loan while letting you enjoy the relatively lower floating rate. But there is another way to look at it - you're not benefitting fully from either option.

In summary, go for floating rate if you want the lowest interest rate and are willing to risk it going higher. Go for fixed interest rate if you want the certainty. If you really want to hedge your bets, then pick a hybrid package.

4. Refinance your bank loan while you have the opportunity

Refinancing is the act of signing a new bank loan package with new terms on interest rates, loan amount, and payment schedules.

Whenever you refinance, you tend to find a better deal compared to your existing home loan. Even in a rising interest rate environment, you may still find such opportunities to refinance for a better deal. And if there’s an opportunity to save, why not?

This article was first published in Mortgage Master.