Home loan repayment is one of the highest consumption items for households in Singapore. Ideally it can only take up to 35% of your gross income if you don't have any other debts (MoneySense, Singapore's national financial education programme, recommends that your total debt should not exceed 35% of your gross income).
However, keep in mind that the Mortgage Servicing Ratio (MSR), i.e. proportion of your monthly gross income spent on mortgage repayment, cannot exceed 30% for purchase of HDB flats.
Also, your Total Debt Servicing Ratio (TDSR) cannot exceed 60% of your gross monthly income. And remember that apart from home loans, this includes car loans, education loans, personal loans, credit card debt, and all other debts.
According to the Department of Statistics Singapore, 90.8% of Singapore households in 2015 were homeowners. And it is common to have floating home loan rates that are linked to SIBOR and SOR. The majority of housing loan packages offered by banks in Singapore are pegged to floating rates, with some 50% of overall banks' housing loan packages pegged to SIBOR/SOR and the rest being board-rate and fixed-rate packages.
In GET.com's guide to SIBOR and SOR-pegged home loans, we explain how a minor increase in SIBOR rates could result in a significant increase in home loan payments.
It's important to understand that SIBOR and SOR interest rates are affected by the U.S. Federal Reserve, which has just hiked up its rates for the second time in a decade by a quarter percentage point to between 0.50% and 0.75%.
Singapore banks are first and foremost regional intermediaries. According to the October 2015 report from the Federal Reserve Bank Of San Francisco, Singapore banks are now borrowing mainly from developed Asian countries, New Zealand and Australia, before lending out to emerging Asian countries.
So the consequence of the Fed raising interest rates is that the cost of funds will rise as Singapore banks will have to pay more to their lenders, as well as higher rates when borrowing from each other.
In addition, international capital moved out of the U.S. in search of higher yield when the Fed cut interest rates to 0.25% in 2009. Now that the Fed has raised interest rates once again with the intention of increasing its interest rates three times in 2017, currencies and equities of emerging markets may come under pressure, resulting in an even bigger outflow of capital for emerging markets.
This is expected to accelerate in 2017 and it will inevitably put even higher pressure on the cost of funds for local banks.
First Fed Rate Hike In 2016
The Federal Reserve moved to raise interest rates by 25 basis point on 14 December 2016 and this is a significant event for home owners. The exact words that changed this are:
"Today (14 December 2016), the Federal Open Market Committee decided to raise the target range of the federal funds rate by one-quarter percentage point, bringing it to one-half to three-quarters percent. In doing so, my colleagues and I are recognizing the considerable progress the economy is made toward our dual objectives of maximum employment and price stability."
U.S. Recovery
What drove the Fed to raise interest rates the second time in nearly a decade?
Fed Chair Janet Yellen explained this clearly in her press conference as quoted below:
"Over the past year, two and a quarter million net new jobs have been created, our unemployment has fallen further, and inflation has moved toward longer run goal of two percent. The committee judged that the modest increase in the federal funds rate is appropriate in light of the solid progress we have seen toward our goals of maximum employment and two percent inflation.We continue to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate over time to achieve and maintain our objectives. We continue to expect that gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance."
In other words, the Fed raised interest rates because the U.S. economy has had a strong recovery and higher interest rates are now apt. One has to keep in mind that when interest rates are low, it comes at the expense of savers in insurance and pension products.
We can gauge the recovery of the U.S. economy from the labour market. After peaking at 10.2% in October 2009, the unemployment rate is now at 4.6% as of November 2016, as the U.S. economy expanded steadily.
Wages are also rising in the U.S. as a tightening labour pool forces companies to pay more for talent. Wages range from an average of $16 per hour to $21 per hour. Just to illustrate this better with some numbers, wages in the U.S. have risen 4.32% in October 2016 over the same month in 2015.
Among all the advanced economies, the United States remained on the firmest path of economic recovery. This is part of the ongoing global recovery story which is supported by research by Goldman Sachs.
Interest Rates Rise In Anticipation
On November 17, the Federal Reserve chair Yellen announced that a rate hike could come "relatively soon" as "the case for an increase in the target range had continued to strengthen". Just to reiterate, employment and inflation are the twin mandate of the Fed. So when the Fed chair announced that both targets are about to be met, it was a strong signal for the market.
Even before the interest rate hike for 2016 was made official, local interest rates had risen a day before the Fed's announcement was made. The 3-month SIBOR increased by 0.006% from 0.926% on Tuesday (13 December) to 0.932% (14 December) while the more volatile 3-month SOR rose by 0.062% to 0.818% on Tuesday, up from 0.756% on Monday (12 December).
This latest rate report came from Association of Banks Singapore (ABS) which provides SIBOR and SOR rate updates on a weekly basis. SIBOR and SOR are closely linked and they move in the same direction. Here you can learn more about SIBOR and SOR home loans.
The key rate to look at for home loans is the 3-month SIBOR rate as this is the rate which most home loans in Singapore use.
What Will Interest Rates Be In 2017?
The Fed promised a gradual rate hike and pledged to keep monetary conditions accommodative. Hence for borrowers, they should be focused on the pace and level of the rate hike in 2017.
So the questions we should be asking are: where will interest rates be in 2017 and how fast will they rise?
In fact, the Fed has already signalled a faster pace of hikes for the coming year in light of the Trump administration's promises to strengthen growth through deregulation, spending, and tax cuts. Instead of the once-a-year hike that we have just witnessed and also in 2015, the Fed is projecting three rate hikes for 2017.
At the moment, the Fed has forecast another three hikes in both 2018 and 2019 before the Fed funds rate trails off at a "normal" projected long-run rate of 3.0% in the near future, taking into consideration its expectation of the U.S. economy gaining traction.
So, what now? Frankly speaking, only time will tell.
As a home owner, you should move early in anticipation of the projected rate hikes next year which are likely to raise the Fed funds rate from the current 0.75% to 1.5% by the end of 2017.
What can you do? You can refinance your floating-rate home loan to a fixed rate home loan or you can refinance to a longer interest rate term (e.g: 12-month SIBOR) instead of the standard 3-month SIBOR.
Here at GET.com, you can compare home loans to find the cheapest home loans in Singapore.
Denise Bay is a staff writer at GET.com. Email: denise.bay@get.com.
Source: GET.com