In the past few quarters, we have seen how mortgage interest rates have skyrocketed. From below 2% years back to now over 4%. With higher interest rate, owners of properties with mortgages will have to paying more for their monthly instalment. This increase could put pressure on property owners who are not able to meet the increased instalment payment commitment.
However, if you were to look closely and compare the interest rate movement vs the price index movement of the current property market, property prices are still picking up even though interest rate is increasing. So, the question now most of us could be asking; how does this interest rate increase impact individual property owners?
Chart of interest rate
URA price index
How interest rate increase affect instalment?
First, let us look at how much your instalment can increase as the interest rate increase.
Assuming you took a $1M loan for 25 years tenure, here is how the instalment looks like at different interest rates.
| Interest Rate | 2% | 3% | 4% | 5% | 6% |
| Instalment | $4,238.54 | $4,742.11 | $5,278.37 | $5,845.90 | $6,443.01 |
| % Increase from 2% | 0% | 12% | 25% | 38% | 52% |
As the interest rate increases, the instalment also increases correspondingly. Here we can see that even if interest rate double from 2% to 4% the instalment does not double. It increases by 25%. When interest rate increases from 2% to 6%, the instalment increases by about 52%. Thus, do not think that when interest rate doubles, your instalment will also double. The instalment will increase a at fraction of it.
How does it affect property owners?
In the property market there are different categories of property owners. Let us take a look at how this interest rate increase can affect them.
Own 1 property for own stay
If there is still an outstanding loan for this group of property owners, the interest rate increase may impact them. Some of these owners may still be enjoying the previous lock-in loan interest rate package, so they may not be affected by this interest rate increase.
For those who are on floating interest rate package, the additional amount of instalment that they must fork out monthly will be as illustrated in the interest rate increase table above. So, what can this group of property owners do? One option is to fully pay, or they can consider doing a partial payment towards the loan of the property if they have the resources to do so to bring down the monthly instalment amount.
Own 1 property and rented out
Property owners who bought property for pure investment purposes may not find the interest rate increase a big problem. Why?
Let us look at the instalment table again.
| Interest Rate | 2% | 3% | 4% | 5% | 6% |
| Instalment | $4,238.54 | $4,742.11 | $5,278.37 | $5,845.90 | $6,443.01 |
| % increase from 2% | 0% | 12% | 25% | 38% | 52% |
Assuming the buyer bought a property when the interest rate was at 2% say 2 years ago. The instalment for this interest rate is $4,238.54. Assuming the buyer can be a rental yield of 3.5% then, the corresponding rental is $3,889.
If we look at how property rental index has increased over the last 2 years, we can expect the rental on the property to have increased now.
Over the last 2 years, property rental rate has increase by 29.4%. Factoring this rental increase, the rental of $3,889 two years ago will now be $5,032.37. If interest rate increased from 2% to 4% over the same period, the instalment now would be $5,278.37. Therefore, the impact of the interest rate increase for this group of property owners will be mitigated by the rental increase. However, if property rental rates were to decrease, it will negatively impact this group of owners.
Own 2 Properties, 1 for own stay and 1 rented out
If the owners have 2 properties, one of it is for own stay and the other is rented out, then the impact on this group of owners will mainly come from the own stay property (see Own 1 property for own stay Scenario).
As illustrated in the Own 1 property and rented out scenario above, due to the increase in the rental rate, the interest rate increase does not have a big impact on the second rental property.
What should be the strategy when buying a property?
No one can be 100% sure of how the interest rates will move or exactly where the property market is going to head in the years ahead. However, one thing we can be sure of is that property market can go up and down so as interest rates. Therefore, one of the most important things that property purchasers should do is to plan and prepare for contingencies. For example, one of the strategies that we can use to prepare for rate increase is by doing a financial stress test before purchasing the property.
I will advice that before purchasing any property, adopt a clear risk management process so that your property purchase will be “safe”. If in doubt, fill in the form below to request for a planning session.