With the global economy starting to recover from the pandemic, we can expect interest rates to pick up. This will directly affect our mortgage loan and we will be expected to pay more for our monthly mortgage. For those who are already on a very tight budget now (after paying their monthly mortgage) this interest rate increase may spell big trouble for them. Any increase in the loan interest rate could have a significant impact on the finances of the family.
You may be wondering, what is the extend of this interest rate increase will affect you? What if interest rate were to double, do my monthly instalment double also? Am I prepared for the increase? If I am not prepared, what can I do now?
Is the increase really that scary?
Any increase in the interest rate will results in an increase in our property’s monthly mortgage instalment. If my loan interest rate doubles, what will happen to my monthly instalment?
Let us work on an example here:
If I am age 35, having an outstanding mortgage loan of $1,000,000 of 30 years loan tenure. If the interest rate were to increase from 1.5% to 3%, what will be the corresponding increase in my instalment?
Instalment at 1.5% interest rate: $3,451.20
Instalment at 3.0% interest rate: $4,216.04
Instalment increase: $764.84
Percentage increase: 22.2%
What we can see here when interest rate doubles, the monthly instalment does not double. It increases only by about one fifth. The doubling of interest rate is not as scary as it seems initially. Instalment generally do not double when interest rate double.
However, if right now we are barely able to afford to pay our monthly instalment (even with a lower interest rate now), this $764.84 or 22.2% increase in instalment will have a major consequence on our financial situation. In this case, it can get really scary.
Does instalment increase by the same amount for everyone?
Does interest rate increase affect you and me the same way? How will the increase affect the different age group of people?
I have work out a table below to compare from age 35 to age 55, how much will the instalment look like for the different age groups, if interest rates were to increase from 1.5% to 3.0%.
| Age | 35 | 45 | 55 |
| Loan tenure | 30 | 20 | 10 |
| Loan amount | $ 1,000,000 | $ 1,000,000 | $ 1,000,000 |
| Instalment at 1.5% interest rate | $3,451.20 | $4,825.45 | $8,979.15 |
| Instalment at 3.5% interest rate | $4,216.04 | $5,545.98 | $9,656.07 |
| Difference in instalment | $764.84 | $720.52 | $676.92 |
| Percentage increase in instalment | 22.2% | 14.9% | 7.5% |
We can see from the table above, the interest rate increase affects the younger group of property owners more. The instalment increase is a whopping 22.2% for those at age 35 compared to 7.5% for those at age 55.
Why is it that the younger group is being impacted most?
In the payment towards our mortgage loan, there are 2 components when we pay our monthly mortgage. They are the payment towards the loan’s principal and the payment towards the interest charged on our loan.
At a younger age, you can stretch out your loan for a longer tenure. With a longer loan tenure, a bigger portion of your monthly instalment will be used to pay towards the interest charged on your loan compared to one with a shorter loan tenure. Thus, any interest rate increase will affect the younger group more.
Therefore, if we fall into the age range of age 35 to 45, it is important now for us to relook at our situation and assess the extend and the impact of any interest rate increase on our financial situation.
How will it affect me as a property investor?
As a property investor, one of my biggest concern will be the rental returns I am getting from my property. We rent out our property so that our rental income can cover partly, if not cover fully our housing instalment.
If interest rate doubles, will the rental still be sufficient to cover most of my instalment?
Again, let us look at an example:
Assuming the monthly rental income we are collecting from our property rental is $3,000 and the outstanding property loan is $1,000,000. The table below will illustrates how much we have to top up to pay towards our monthly instalment if interest rate were to double.
| Age | 35 | 45 | 55 |
| Monthly Rental (A) | $ 3,000.00 | $ 3,000.00 | $ 3,000.00 |
| Instalment at 1.5% interest rate (B) | $3,451.20 | $4,825.45 | $8,979.15 |
| Top up at 1.5% interest rate (A) – (B) | $451.20 | $1,825.45 | $5,979.15 |
| Instalment at 3% interest rate (C) | $4,216.04 | $5,545.98 | $9,656.07 |
| Top up at 3% interest rate (A) – (C) | $1,216.04 | $2,545.98 | $6,656.07 |
The table above have provided us some ideas on how much we will need to top up towards our instalment payment in the event that interest rates were to increase. Hope it can provide you with a reference on how much you have to top up on your monthly instalment if interest rate were to increase. Hope it can help you to plan in advance, and to understand how interest rate increase could pose a risk for you.
How can I counter the effect of interest rate increase?
It will all boils down to proper a risk management strategy. As mentioned in many of my previous articles, having a buffer fund is one of the key to mitigate any interest rate increase. By having excess savings in my bank or CPF account, I could utilize this excess amount to help me to pay towards the increased in the instalment.
Another way to counter the impact of interest rate increase is to refinance your loan. If your current loan is ready for refinancing (without any lock in penalty), you may consider refinancing it to a lower interest package. Or you can go for a fixed interest loan package to provide you with more certainty.
One other to reduce the impact is to stretch out your loan tenure. With longer loan tenure, you will be able to bring down the monthly instalment amount. With lower monthly instalment, your monthly rental income should be able to cover a bigger portion of your monthly instalment.
Increasing the rental yield from your property could be another solution. You can consider to better furnish your property or even renovating it to increase the yield you can get from renting it out. Of course, if your condo is already in a location with limited supply, it may be easier for you to increase the rental yield.
What have we learned?
Before making any property purchase, it is important to consider how future interest rate increase will affect our financial situation. By doing a “stress test” on our financial situation before any purchase is strongly recommended. Another important factor is to know where to buy the right property so that I will always enjoy a good rental yield and my property will always be able to be rented out.
If you are clueless on how to do a financial “stress test” before buying a property, or how to pick the right property to buy, feel free to contact me using the form below.