The hike in interest rates over the past few months has been under media scrutiny. The warnings range from further pressure on property prices to a possible surge in distressed sales. Prospective buyers are counting on the hike in interest rates and a potential supply glut to cause property prices to tank before they are prepared to commit on the dotted lines. This exercise seeks to explore whether the rise in interest rates should be a cause for worry.
The 3-month Singapore Interbank Offered Rate (SIBOR 3M), a key benchmark rate for many mortgages has spiked to around 1.01% as at end of 1Q2015, up from 0.45% in 3Q2013 when prices were at their peak. It is expected to rise further, with OCBC forecasting it to hit 1.32% in December 2015.
Mortgage rates are commonly computed as SIBOR 3M + a spread. We have based our analysis for condominiums and Housing and Development Board (HDB) flats on a 30-year and 25-year mortgage respectively at 80% loan-to-value (LTV). Interest rates were computed based on prevailing SIBOR 3M + 0.8% for the first 3 years and SIBOR 3M + 1.0 % for subsequent years.
Increase in mortgage payment manageable
Suppose a buyer purchased a $1 million condominium at peak prices in July 2013 and took a 30-year loan at 80% LTV or $800,000. His monthly mortgage is estimated to start at about $2,666 in July 2013.
If SIBOR 3M were to rise to 1.32% in December 2015, his monthly mortgage would climb to $2,984 and then to $3,058 once the mortgage crosses the fourth year mark. This translates to an increase of between $300 and $400.
On the other hand, monthly household income rose by an average of $514 per annum over the past five years. Using this growth rate to project the 2015 household income, the mortgage to income ratio would remain largely unchanged at 28% despite the increase in interest rates (see Table 1).
Table 1: Monthly mortgage for a $1 million condo versus islandwide household income
The impact of higher interest rates would be lesser for more economic properties such as a $400,000 Housing and Development Board (HDB) flat. The higher interest rates would up the monthly mortgage from $1,243 in July 2013 to $1,365 in December 2015 and then to $1,393 from the fourth year onwards.
This represents a monthly increase of less than $200. In the meantime, the average monthly income for households staying in 4-room HDB flats rose at an average of $432 per annum over the past five years. As a result, the mortgage to income ratio edged up by only 1 percentage point with the hike in interest rate (see Table 2).
Table 2: Monthly mortgage for a $400,000 HDB versus household income of HDB 4-room dwellers
The impact of higher interest rates would be more pronounced as the loan quantum gets bigger or with multiple loans. For example, the monthly mortgage for a $2 million condominium would start at about $5,272 in July 2013. It would surge to almost $6,000 by end of 2015 and about $6,100 from the fourth year onwards, representing an increase of about $850. Though hefty, the increase in mortgage payment is manageable given that the monthly household income of condominium dwellers rose at an average of $823 per annum over the past five years.
Comparing the increase in monthly mortgage against higher household income, we do not expect a significant impact of higher interest rates on property prices. However, the resounding headlines have led to many home buyers to wait on the sidelines in an attempt to time their purchases at the trough.
Looking for answers in the wrong places
In reality, the real danger to the property market does not lie with higher interest rates, but with the macroeconomic outlook and overleveraging. In a dual-income household, a loss of one income would jack up the mortgage to income ratio significantly, which might result in a distressed sale of the property, something that prospective buyers are eagerly waiting for. However, this might be just a wishful thinking considering the unemployment rate is at a low 1.8% and the economy is projected to grow positively, albeit at a modest pace of 2% to 4%.
The Government had also interceded early against overleveraging. Before prices peaked in 3Q2013, the LTV limit for second property loan has been tightened several times from 80% before August 2010 to just 50% today. This would diminish the multiplier effect of higher interest rates on multiple property loans. Finally, the Total Debt Servicing Ratio has been in place for nearly two years now to ensure prudent leveraging among buyers.
Rising interest rates or not, prospective buyers are advised to be prudent when evaluating their affordability level. This is where the 30% mortgage to income ratio comes into the picture, to account for the worst case scenario such as a loss of income or a margin call.
The SIBOR 3M averaged 1.27% over the past decade and a spread of 1% would put the interest rate at 2.27%. Based on this rate, a household earning $10,000 would be prudent to buy a property with a loan of up to $780,000 which would translate to monthly mortgage of close to $3,000 or 30% mortgage to income ratio.
If SIBOR 3M were to hit the decade’s high of 3.56%, the mortgage to income ratio would climb 10 percentage points to 40%. On the other hand, if a dual income household loses one source of income, the $3,000 monthly mortgage would catapult the mortgage to income ratio to 60% even without any increase in interest rates, assuming both parties earn the same amount. The prospect of the property market, therefore, hinges more on the macroeconomic outlook rather than interest rate positions.
This article appeared in The Edge Property Pullout of Issue 678 (May 25) of The Edge Singapore.