How High Can Mortgage Rates Go?

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By Mr. Propwise

Home buyers with loans pegged to the Singapore Interbank Offered Rate (SIBOR) have recently had some unpleasant experiences with their ballooning mortgage repayments.

First, we saw the three-month SIBOR rise above 1 per cent for the first time in six years. This means all loans pegged to it will start to re-price in the months ahead. This by itself could lead to a 0.3+% increase in the mortgage rate for many home loans.

Now we are starting to see some banks also increase the margin or spread above SIBOR they use to price these loans. So for people who had taken up loans with lower-than-market spreads, they are finding that once they get out of the lock-in period banks have been proactive in raising those up to or above the 0.85% “market” spread.

The net effect is that in just over a year typical mortgage rates have gone from closer to 1 per cent to closer to 2 per cent, an effective doubling.

You ain’t seen nothing yet

The natural question then is – how high can SIBOR and hence mortgage rates go?

If history is any guide, much, much higher. Just as recently as 2006 (before the Global Financial Crisis), SIBOR was as high as 3.5%, meaning that a typical mortgage rate could be around 4.5%. If we look at averages, the 27-plus year average of the three-month SIBOR is around 2.50%.

Figure 1 – 3-Month and 12-Month SIBOR rates since 1987 (Source: PropertyMarketInsights.com)

So while it feels like SIBOR rates have rocketed up by more than doubling, this could just be the beginning of the increase.

Quantitative Easing (QE) and its tapering

We should keep in mind that the root cause of the buoyant property prices is the protracted low interest rate environment after multiple rounds of Quantitative Easing (QE) by the US Federal Reserve post the Global Financial Crisis. This has propped up the prices of most yield-based assets, including property. While the Fed has indicated a gentle pace of QE tapering, the market reaction to any significant tightening of liquidity could be stronger and more violent than people expect.

And even if interest rates do not shoot up right away, we’ve already seen how borrowing costs can still rise as banks charge a higher margin (SIBOR + X%) to give themselves a buffer against rising interest rates and greater mortgage defaults. And when borrowing costs rise, the stress on heavily leveraged buyers will go up, and the attractiveness of property itself as an asset class also decreases as the net cashflow it provides falls.

As rentals are also weak, this hurts the ability of some borrowers to service their loans. And if for whatever reason unemployment increases, then we have the making of a perfect storm for the property market.

A concrete example of the impact of rising mortgage rates

Many property buyers are still blasé to the impact of rising mortgage rates (whether from rising interest rates or banks raising their lending spread) on their ability to meet their monthly payments, so I hope to make it more concrete by using an example.

Let’s take the case of the Tans, a young professional couple who bought their dream condo for $2 million (before the TDSR rules came into effect). They took an 80% loan ($1.6 million) with a 30-year tenor. With the current low floating mortgage rate of 1.2%, their monthly payment is $5,294, a manageable 50% of their total household income.

Fast forward a couple of years, when the Fed has raised rates and mortgage rates in Singapore have returned to their long term average of around 4%. The monthly payment will get re-priced upwards to $7,639, and now accounts for a hefty 72% of their household income (assuming no pay increments). This represents a 44% increase.

The Tan are starting to sweat, and are barely making ends meet. And what if someone lost his or her job? Not to mention that this rise in rates is coupled with weak rentals and record completions, and property prices falling every quarter.

Sadly, we are approaching a time where this hypothetical scenario could become much more realistic.

By Mr. Propwise, the founder of Singapore property blog www.propwise.sg, which aims to help people make better real estate buying, selling, renting and investing decisions.

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